DEFINITION of 'Equilibrium'

Equilibrium is the state in which market supply and demand balance each other and, as a result, prices become stable. Generally, when there is too much supply for goods or services, the price goes down, which results in higher demand. The balancing effect of supply and demand results in a state of equilibrium.

BREAKING DOWN 'Equilibrium'

The equilibrium price is where the supply of goods matches demand. When a major index experiences a period of consolidation or sideways momentum, it can be said that the forces of supply and demand are relatively equal and that the market is in a state of equilibrium.

As proposed by New Keynesian economist and Ph. D. Huw Dixon, there are three properties to a state of equilibrium; the behavior of agents is consistent, no agent has an incentive to change its behavior, and that the equilibrium is the outcome of some dynamic process. Dr. Dixon names these principles equilibrium property 1, or P1, P2, and P3 respectively. 

Economists like Adam Smith believed that a free mark​et would trend towards equilibrium. For example, a dearth of any one good would create a higher price generally, which would reduce demand, leading to an increase in supply provided the right incentive. The same would occur in reverse order provided there was excess in any one market. The understanding of this series of cause and effect were all viewed in a vacuum.

Modern economists point out that cartels or monopolistic companies can artificially hold prices higher and keep them there in order to reap higher profits. The diamond industry is a classic example of a market where demand is high, but supply is made artificially scarce by companies selling fewer diamonds in order to keep prices high.

The term used for when markets are not at equilibrium is disequilibrium. Disequilibrium either happens in a flash, or is a characteristic of a certain market. At times disequilibrium can spillover from one market to another, for instance if there aren’t enough companies to ship coffee internationally then the coffee supply for certain regions could be reduced, effecting the equilibrium of coffee markets. Economists view many labor markets as being in disequilibrium due to how legislation and public policy protect people and their jobs, or the amount they are compensated for their labor. 

Paul Samuelson argued in a 1983 paper Foundations of Economic Analysis published by Harvard University that giving equilibrium markets what he described as a ‘normative meaning’ or a value judgment was a misstep. Markets can be in equilibrium, but it may not mean that all is well. For example, the food markets in Ireland were at equilibrium during the great potato famine in in the mid 1800s. Higher profits from selling to the British made it so the Irish/British market was at equilibrium price was higher than what farmers could pay, contributing to one of the many reasons people starved. 


  1. Supply

    A fundamental economic concept that describes the total amount ...
  2. Gerard Debreu

    A French-American economist and mathematician and winner of the ...
  3. Walras' Law

    An economics law that suggests that the existence of excess supply ...
  4. Supply Shock

    An unexpected event that changes the supply of a product or commodity, ...
  5. Orderly Market

    Any market in which the supply and demand are reasonably equal. ...
  6. Demand

    An economic principle that describes a consumer's desire and ...
Related Articles
  1. Active Trading

    Why You Can't Influence Gas Prices

    Don't believe the water-cooler talk. Big oil companies aren't to blame for high prices.
  2. Options & Futures

    Explaining The World Through Macroeconomic Analysis

    From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone.
  3. Retirement

    Economic Indicators To Know

    The economy has a large impact on the market. Learn how to interpret the most important reports.
  4. Investing Basics

    Why Interest Rates Affect Everyone

    Learn why interest rates are one of the most important economic variables and how every individual and business is affected by rate changes.
  5. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  6. Economics

    Understanding Donald Trump's Stance on China

    Find out why China bothers Donald Trump so much, and why the 2016 Republican presidential candidate argues for a return to protectionist trade policies.
  7. Investing

    World Bank Data For Dummies

    Developing countries can't always afford to track the data crucial to setting the right economic policies and programs. That's where the World Bank steps in.
  8. Economics

    Explaining Devaluation

    Devaluation is the deliberate decrease in one county’s currency relative to the currency of other countries.
  9. Investing

    Is US Inflation Too Low?

    One reason the Fed has delayed its first rate hike: U.S. inflation has been persistently running below the stated 2 % level the central bank seeks to target.
  10. Investing

    2 Investing Implications of Higher US Rates

    While U.S. economic data continue to come in mixed, the numbers still point to decent U.S. economic growth.
  1. Which economic factors impact treasury yields?

    The economic factors that impact Treasury yields are interest rates, inflation and economic growth. All of these factors ... Read Full Answer >>
  2. How do I decide whether a credit card offer is a good deal or not?

    Externalities lead to market failure because the price equilibrium does not accurately reflect the true costs and benefits ... Read Full Answer >>
  3. Is the law of supply and demand a law or just a hypothesis?

    The law of supply and demand is actually an economic theory that was popularized by Adam Smith in 1776. The principles of ... Read Full Answer >>
  4. What are the best technical indicators that complement the Price Rate Of Change (ROC)?

    Some of the best technical indicators to complement a trading strategy using the price rate of change, or ROC, are moving ... Read Full Answer >>
  5. Do production possibility frontiers have multiple possible equilibria?

    Production possibility frontiers involve the trade-off of inputs within an economy and can possess multiple possible equilibria. ... Read Full Answer >>
  6. Are APRs different in different countries?

    Money lenders of all types, ranging from credit card companies to mortgage lenders, are free to charge any interest rates ... Read Full Answer >>
  7. What are the key factors that cause the market to go up and down?

    It is difficult to identify specific factors that influence the market as a whole. The stock market is a complex, interrelated ... Read Full Answer >>
  8. What causes a significant move in the stock market?

    There is a nearly infinite number of factors that can cause the stock market to move significantly in one direction or another. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center