The understanding of the market equilibrium concept and its importance in macroeconomics is an invaluable skill for business managers. The concept of market equilibrium has surfaced severally in the American financial market (Ball, 2009). However, this paper defines the concept of market equilibrium through the 2007/2008 housing bubble that hit the American property market. This analogy suffices through the understanding of the laws and demand and supply.
Law of demand and Causes of demand
The concept of the law of demand revolves around fluctuations in price and supply. The law of demand stipulates that high prices lead to lower demand and low prices lead to high demand for goods and services (McConnell, Brue, & Flynn, 2009). This analogy outlines an inverse relationship that varies demand and price. Albeit economists perceive the price to be the main cause of supply, other factors also affect the demand for a good or service. For example, macroeconomic factors of a population, like the level of income and the availability of substitute products, influence the demand for goods and services. Variations in the above factors shift the demand curve to either the right or left, as shown below.
The point at which the demand and supply meet is the equilibrium (Eq).
Law of Supply and the Causes of Supply
The law of supply closely relates to the law of demand because both concepts use price variations to explain their relationships. The law of supply states that high prices are synonymous with a high supply of products and services, while low prices are synonymous with a low supply of products and services (Pugel, 2009). The above statement describes a positive relationship between price and quantity. Again, like demand, other factors, besides price, affect supply. These factors may include technology, production costs, number of sellers in the market, and future expectations of prices. Variations in either of these factors shift the supply curve to either the left or the right, as demonstrated in the supply curve below.
The 2007 housing bubble provides a good example of the forces of supply and demand because an oversupply of demand for property precipitated the crisis. A deregulated economy and the easy access to credit led to an artificial growth of the property market. Many Americans were, therefore, willing to buy property, thereby sharply increasing the demand for property. This sharp increase in demand led to a significant sharp increase in the price of the property, thereby creating an imbalance between supply and demand in the property market.
Surplus and Shortage
If there is an imbalance between supply and demand, a market experiences surpluses and shortages. This may occur in two ways – the quantity supplied may surpass the demand (surplus), or the demand may exceed the quantity supplied (shortage). In the US housing bubble, some companies made easy profits through this imbalance until the housing bubble burst.
Efficient Markets Theory
In practice, the efficient markets theory stipulates that the lower the transaction costs in a market, the more efficient the market should be. The efficient markets theory, therefore, expects that the price of a product should reflect all relevant information about the product (Pugel, 2009). However, the prices in the 2007 US housing market did not reflect the right information about the market. Through this understanding, the property market was inefficient, thereby leading to the “bubble burst.”
The concept of market equilibrium requires that the demand and supply of a product should match. This paper shows that the US housing bubble brought an imbalance in the supply and demand for property. This imbalance had to offset through the resulting financial crisis. Through the crisis, it is correct to say demand and supply naturally offset one another, albeit slowly. An equilibrium position is therefore, ideal for any business or market.
Ball, L. M. (2009). Money, banking, and financial markets. New York, NY: Worth Publishers.
McConnell, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics: Principles, Problems, and Policies (18th ed.). Boston, MA: McGraw-Hill Irwin.
Pugel, T. A. (2009). International Economics (14th ed.). Boston, MA: McGraw-Hill Irwin.