A market is a way of resolving the problem of choosing how to allocate scares resources. This choice is determined by the equilibrium of supply and demand. Markets can be found in many different forms, from the street bazaars to the stocks and shares exchange markets.
Market Clearing under Perfect Market ConditionsEdit
|Price||Demand (number of melons demanded)||Supply (number of melons supplied)|
Assuming that the market is perfect, which means there is perfect competition and thus no market failure, equilibrium is achieved through a process of market signals. At this equilibrium there is no excess supply, where the quantity supplied exceeds the quantity demanded at the ruling price, and no excess demand, where quantity demanded is above quantity supplied at the ruling price.
Imagine that a perfect market for melons is defined by Table 1 and that Diagram 1 is the visual interpretation of the information in Table 1. Suppose that at first the ruling price is £4. at this price quantity demanded is 2 melons while supplying firms are offering 6 melons, so excess quantity of supply is 4 melons. In order to clear their stocks, supplying firms proceed to reduce the price to £3 where they manage to sell all of their stock. At price of £3 the consumer also exhibit no excess demand, therefore £3 is the equilibrium price at which the market clears.
If the ruling price, on the other hand, was £2 then supplying firms, assuming that all the supplying firms are profit maximisers, will quickly run out of melons to sell and so excess demand of 4 melons will exist. The firms will start to ask for a higher price for their melons in order to take advantage of the excess demand and thus possibly generate higher profit, potential for which rises as revenue rises which is brought about by higher price.
Joan Robinson's Critique of General Equilibrium TheoryEdit
For the sake of simplicity the theory of equilibrium is based on abstraction of the real world. Specifically one must assume that the firms who operate in a market always respond to price changes by changing their production in order to come back to the long term equilibrium which is constant. This abstraction does help to create a one-to-one model where the past is just as determined as the future is. However some economists, notably Joan Robinson, argue that such level of abstraction leads to unrealistic assumptions to be made and thus the model is nothing more then an idle amusement.
Robinson argued that the firms may respond differently to changes in price which then may lead to an entirely new equilibrium. For example a ruling price which is higher then equilibrium price may lead to firms revising their expectation of what the usual market price is and change production to accommodate this new price. If the ruling price happens to be below equilibrium price firms may choose to introduce new technological innovations which make production profitable at that ruling price.
This thinking leads to the conclusion that the equilibrium theory may lead to different outcome compared to actual economic activity. More importantly one has to consider that the long run equilibrium is not independent of other factors and that changes in price may lead to changes in the general demand or supply. Following Robinson’s thought also leads to inability of comparison of two equilibriums on the same diagram because both are based on different original parameters and thus one equilibrium cannot automatically be assumed to be the predecessor of the other.
Therefore doubts exist about the suitability of modelling outcomes of actual economic process with the equilibrium theory.
- David Begg, Economics 7th edition, 2003 (ISBN 0-07-709947-8)
- Susan Grant, Chris Vidler, Economics in Context, 2000 (ISBN 0-435-33111-6)