Model Answer
0 min readIntroduction
Market equilibrium, a cornerstone of economic analysis, represents a state where the forces of demand and supply balance, resulting in stable prices and quantities. The ‘existence’ of equilibrium refers to whether a stable price and quantity combination actually exists in the market. ‘Uniqueness’ refers to whether there is only one such stable combination. Traditionally, under standard assumptions of upward-sloping supply and downward-sloping demand, a unique equilibrium is guaranteed. However, when both curves slope downwards, the conditions for existence and uniqueness become more complex, potentially leading to scenarios with multiple or no equilibria.
Existence of Equilibrium
Existence of equilibrium implies that a price-quantity combination exists where quantity demanded equals quantity supplied. In a standard market with a downward-sloping demand curve (D) and an upward-sloping supply curve (S), the intersection of these curves guarantees a unique equilibrium. However, when both demand and supply curves are downward sloping, the existence of equilibrium isn’t automatically assured.
If the curves never intersect, no equilibrium exists. This can happen if the initial supply curve lies entirely above the demand curve, or vice versa. However, even if they intersect, the stability of that intersection needs to be considered.
Uniqueness of Equilibrium with Downward-Sloping Curves
The uniqueness of equilibrium is threatened when both demand and supply curves are downward sloping. This is because of the potential for multiple intersections, leading to multiple equilibria. Let's consider a scenario:
- Downward-Sloping Demand (D): Represents the typical inverse relationship between price and quantity demanded.
- Downward-Sloping Supply (S): This can occur due to economies of scale, learning by doing, or a decrease in input costs as output increases.
When both curves slope downwards, three possible scenarios can arise:
- Unique Equilibrium: The curves intersect at a single point. This is possible, but less common.
- Multiple Equilibria: The curves intersect at two or more points. This means there are multiple price-quantity combinations where the market can settle. Which equilibrium the market converges to depends on the initial conditions (starting price).
- No Equilibrium: The curves do not intersect at all.
Illustrative Diagram
Imagine a graph with price on the Y-axis and quantity on the X-axis. Draw a typical downward-sloping demand curve. Now, draw a downward-sloping supply curve. You can easily visualize how the supply curve can intersect the demand curve at multiple points, or not at all, depending on their slopes and positions.
Example: Labour Market with Increasing Returns to Scale
Consider a labour market where firms experience increasing returns to scale in production. As they hire more labour, productivity increases, leading to a downward-sloping supply curve of labour (firms are willing to hire more at a lower wage due to increased productivity). The demand for labour is typically downward sloping. This scenario can lead to multiple equilibria, with different wage and employment levels.
Stability and Path Dependence
In cases of multiple equilibria, the market's initial conditions determine which equilibrium it reaches. This phenomenon is known as path dependence. A small initial shock can lead the market to settle at a significantly different equilibrium. This highlights the limitations of partial equilibrium analysis in such scenarios.
Implications
The non-uniqueness of equilibrium has important implications for policy. Intervention may be necessary to steer the market towards a desirable equilibrium. For example, government policies could aim to shift the supply or demand curve to eliminate multiple equilibria or to encourage convergence to a preferred outcome.
Conclusion
In conclusion, while the existence of equilibrium is generally assured with downward-sloping demand and supply curves, the uniqueness of equilibrium is not. The presence of downward-sloping supply curves introduces the possibility of multiple or no equilibria, leading to instability and path dependence. Understanding these complexities is crucial for effective economic analysis and policy formulation, particularly in markets exhibiting increasing returns to scale or other factors that contribute to downward-sloping supply curves.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.