Market Disequilibrium: Definition, Causes, and Real-Life Examples

Adam Hayes, Ph.D., CFA, brings over 15 years of Wall Street experience as a derivatives trader and is an authority in economics and behavioral finance. Holding a master's degree in economics from The New School for Social Research and a Ph.D. in sociology from the University of Wisconsin-Madison, Adam also teaches economic sociology at Hebrew University in Jerusalem. He holds CFA and multiple FINRA licenses.

What Does Disequilibrium Mean?

Market disequilibrium occurs when internal or external forces disrupt the balance between supply and demand, preventing the market from reaching or maintaining equilibrium. This imbalance can be temporary, caused by sudden changes in market variables, or long-lasting due to structural issues.

The term also applies to imbalances in a nation's balance of payments, where deficits or surpluses indicate disequilibrium.

Key Insights

• Disequilibrium arises when factors disrupt the natural supply-demand balance, causing mismatches.
• It can result from government policies, labor market inefficiencies, or unilateral supplier actions.
• Markets typically self-correct over time, moving toward a new equilibrium.
• For example, higher prices encourage producers to increase supply, eventually stabilizing prices.
• Examples range from rapid flash crashes to prolonged economic recessions.

Grasping the Concept of Disequilibrium

When prices shift due to various influences, the balance between how much is supplied and demanded can be disturbed, placing the market in disequilibrium. Economist John Maynard Keynes initially introduced this idea, highlighting that markets are often not perfectly balanced.

Many economists today view general disequilibrium as a common state due to the complex factors influencing markets.

Market equilibrium is achieved when the quantity supplied equals the quantity demanded at a stable price, eliminating surpluses or shortages. Typically, an excess supply lowers prices and boosts demand, while shortages push prices up, reducing demand. Disequilibrium happens when these natural adjustments fail to restore balance.

Important Note

Market participants tend to exploit price discrepancies, buying undervalued assets and selling overvalued ones, which helps return markets to equilibrium.

Illustrating Disequilibrium in the Market

Consider a hypothetical wheat market where the equilibrium price (Pe) balances supply and demand. If prices rise to P2, suppliers offer more wheat, but consumers buy less, creating a surplus and market imbalance.

The surplus is the gap between quantity supplied (Q2) and quantity demanded (Q1). Suppliers will likely lower prices to clear excess stock, pushing prices back toward Pe.

If prices drop to P1, demand exceeds supply, causing shortages. This scarcity drives prices upward, moving the market back toward equilibrium.

Such inefficiencies indicate disequilibrium, where resources are not optimally allocated.

Factors Leading to Disequilibrium

Disequilibrium can arise from fixed pricing, where prices remain sticky despite changing demand, leading to shortages or surpluses.

Government interventions, like price floors or ceilings, can distort markets. For example, rent controls may reduce available housing, causing excess demand.

Labor markets also experience disequilibrium when minimum wage laws set wages above equilibrium, resulting in excess labor supply.

Balance of payments imbalances, such as persistent trade deficits or surpluses, reflect disequilibrium at the national level. Countries like the US face deficits, while China and Germany run surpluses.

Other causes include currency revaluations, inflation, population changes, and political instability.

Resolving Market Disequilibrium

Markets generally correct disequilibrium through price adjustments or government actions. For labor market imbalances, solutions include retraining workers or policy reforms.

Innovation and improved supply chains can also help companies adjust prices and production to meet demand efficiently.

Real-World Example of Market Disequilibrium

Flash crashes exemplify sudden disequilibrium, where rapid sell-offs cause prices to plummet dramatically. The 2010 Flash Crash saw the Dow Jones Industrial Average drop over 1,000 points within minutes, triggered by automated trading and large sell orders.

This event highlighted how market imbalances can escalate quickly, though markets often rebound once equilibrium is restored.

Frequently Asked Questions About Disequilibrium

What Happens During Disequilibrium?

Prices may become excessively high or low, leading to inefficient markets and economic consequences. Market actors respond by adjusting buying and selling behaviors to restore balance.

What Causes Disequilibrium?

Imbalances between supply and demand, regulatory constraints, and spillover effects between markets can cause disequilibrium. Labor markets often experience this due to wage policies and job protections.

How Can Disequilibrium Be Prevented?

Enhancing market efficiency by reducing barriers, improving information flow, and minimizing regulatory frictions helps maintain equilibrium.

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