The Market Mechanism - Construction Economics: A New Approach - page 53

The Concept of Equilibrium
The concept of equilibrium is important in economics and we will be referring to it
in different markets and in different contexts as we study the economy. Equilibrium
in any market may be defined as:
a situation in which the plans of buyers and the plans of sellers exactly mesh.
Equilibrium prevails when opposing forces are in balance. In any market, the
intersection of a given supply curve and a given demand curve indicates the
equilibrium price. If the price drifts away from this equilibrium point - for whatever
reason - forces come into play to find a new equilibrium price. If these forces tend
to re-establish prices at the original equilibrium point, we say the situation is one of
stable equilibrium . An unstable equilibrium is one in which if there is a movement
away from the equilibrium, there are forces that push price and/or quantity even
further away from this equilibrium (or at least do not push price and quantity back
towards the original equilibrium level).
The difference between a stable and an unstable equilibrium can be illustrated
with two balls: one made of hard rubber, the other made of soft putty. If you
squeeze the rubber ball out of shape, it bounces back to its original form. On the
other hand, if you squeeze the ball made of putty, it remains out of shape. The
former illustrates a stable equilibrium and the latter an unstable equilibrium.
Now consider a shock to the system. The shock can be shown either by a shift in
the supply curve, or a shift in the demand curve, or a shift in both curves. Any shock
to the system will produce a new set of supply and demand relationships and a new
price-quantity equilibrium. Forces will come into play to move the system from the
old price-quantity equilibrium to a new one. Now let us consider a specific example
in the housing market.
A Change in the Conditions of the Market
To illustrate the dynamics of the market imagine what might happen if mortgage
interest rates rise, while other things remain constant. This will reduce the demand
for owner-occupied property at each and every price. This decrease in demand is
shown in Figure 3.5 (see page 54) in the traditional economist way, by shifting
the demand curve to the left from D 1 to D 2 . If property prices now stay at P,
consumers will only demand Q a while suppliers (sellers) will continue providing Q.
Consequently there will be an excess amount of supply in the market place equal
to Q - Q a . However, providing prices are allowed to move to make the amounts
supplied and demanded equal again, suppliers will be able to off-load vacant
properties by reducing their prices. As the price falls consumers will become
interested in buying and demand will increase. Consequently a new equilibrium
price will be arrived at. This new price is P 1 in Figure 3.5 and the new quantity being
demanded and supplied will now be equal to Q 1 .
The shifting of the demand curve (such as in Figure 3.5 ) only occurs when the
ceteris paribus assumption is violated. In other words, the curves only shift to a new
position when the market conditions change. We will explore these 'shifts' in more
detail in the next two chapters.