Disequilibrium refers to a situation where the market forces of demand and supply are out of balance. Disequilibrium can be caused by various factors which can be external or internal. Economic forces may cause a disequilibrium that lasts for a short term. But, it can also be a long-term disequilibrium under certain circumstances.
In the situation of disequilibrium, there may be excess demand or excess supply. This means that either the demand in the market is not able to meet the supply or vice versa. Thus, there can either be a shortage in the market, or a surplus.
While, equilibrium is a state where market forces are balanced. Any changes to this state would lead to a distortion in the economy.
Equilibrium is achieved when an economy is in its natural state without any external intervention. Thus, the goods market equilibrium refers to a state where prices are stable due to the stability of demand and supply.
When prices rise above the equilibrium price, then there can be surplus of goods. Similarly, when prices go below equilibrium price then there can be a shortage of goods. Both cases of a price increase or decrease are examples of disequilibrium. However, this is not a permanent state as markets eventually move towards equilibrium. Notably, market forces adjust to incorporate a shortage or a surplus.
Therefore, disequilibrium is not a long-term state rather is a temporary disbalance in the market forces. Markets acclimate to a new state of equilibrium with relevant policies and regulation.
Markets may move out of equilibrium due to various external factors. However, it is also possible that markets do not always operate on full efficiency. Factors leading to disequilibrium include:
There are two schools of thought that can explain how economies recover from a disequilibrium. According to Keynes, a disequilibrium would not self-regulate. Keynes gave the argument that the natural rate of unemployment is always less than the full employment rate. This happens because there is always a certain degree of frictional unemployment.
Keynesian economics postulates that government intervention is necessary to come out of disequilibrium. Thus, many governments make it a practice to adopt fiscal measures and monetary expansion measures in times of an economic recession or when there are distortions in the economy.
The second approach involves classical school of thought. According to this, any distortion in the economy is self-correcting. Meaning any changes from the equilibrium level are bound to get adjusted on their own, without any external regulations. This is the theory of the invisible hand propagated by the economist Adam Smith. However, this may always be the case as certain instances of disequilibria require immediate action by the government.
Consider the following diagram, where the price level P1 represents a price floor wherein the government fixes a price below which serves as the minimum selling price for the sellers. This means that the sellers need to be paid an amount that is at least equal to P1.
This price floor has led to a market distortion. At price level P1, there is an excess supply of the good. However, at this price not all consumers can purchase the good. Thus, the demand is unable to meet the supply and there is a disequilibrium.
Similarly, a price ceiling P3 ensures that buyers pay maximum amount equal to P3 and not any amount beyond that. However, fixing a price ceiling creates excess demand. Thus, a disequilibrium has set in the economy.
A sudden demand shock can also lead to market disequilibrium. For instance, post a war, or during a global crisis, there might be a sudden contraction in demand. Thus, there would be an economic recession because of this. However, the supply may not adjust as immediately. Thus, there would be excess supply in the economy.
To overcome this, producers would decrease prices so that demand increases. This would lead to adjustment in demand and a new equilibrium would set in as shown in the diagram below. Here, as the Demand curve falls from D1 to D2, there is an excess supply at point B. Thus, when prices are reduced from P1 to P2, the economy moves to point A, which is the new equilibrium point.
What is Keynesian economics? Keynesian economics is the economic theory that states demand is the driver of economic growth. This economic theory also states that fiscal aid helps recover an economy from a recession. Certain Keynesian economic principles stand in stark contrast to the Classical theory of economics. The theory was given by John Maynard Keynes in the 1930s and published in Keynes’ “General Theory of Employment, Interest and Money” in 1936. The Keynesian theory stated that government spending was an essential factor in increasing demand and maintaining full employment. What are the theories under Keynesian economics? Aggregate demand is affected by a host of factors: Aggregate demand is affected by various factors public and private factors. Monetary and fiscal policy both affect the level of aggregate demand in the economy. Any decision taken by the monetary authority or the government greatly affects the economy’s level of demand. Say’s Law proposes that supply generates its own demand. However, Keynesian economics suggests that demand is the driver of supply and overall growth in the economy. Sticky Wages: According to the theory of sticky wages, employers would prefer laying off workers over decreasing the existing workers’ wages. This happens because even in the absence of labour unions, workers would still resist wages cuts. Even if the employers were to reduce wages, it would lead to economic depression as demand would fall and people would become more cautious about their spending. Keynes advocated that the labour markers do not function independently from the savings market. Therefore, prices and wages respond slowly to changes in supply and demand. Liquidity Trap: Liquidity trap refers to an economic scenario where there is a contraction in the economy despite very low interest rates. This contrasts with the relationship between interest rates and investment given in Classical economics. How is Keynesian economics different from Classical economics? Classical economics states that the economy self-regulates in case of a disequilibrium. Any deviations from the market equilibrium would be adjusted on its own without any government regulation. However, Keynesian economics propagates that government intervention must maintain equilibrium or come out of an economic downturn. Keynesian economics highlights the importance of monetary and fiscal policy, while Classical economics does not mention any government intervention. Another crucial difference is that Classical economics suggests that governments should always incur less debt, while Keynesian economics advises that governments should practice deficit financing during a recession. Classical economics states that government spending can be harmful as it leads to crowding out of the private investment. However, it has been later established that this happens when the economy is not in a recession. Government borrowing competes with private investment leading to higher interest rates. Thus, Keynesian economics is of the view that deficit spending during a recession does not crowd out private investment. What are the policy measures advocated by Keynesian economics? According to Keynes, adopting a countercyclical approach can help economies stabilise. This means that governments must move in a direction opposite to the business cycles. The theory also states that governments should recover from economic downturns in the short run itself, instead of waiting for the economy to recover over time. Keynes wrote the famous line, “In the long run, we are all dead”. The short run knowledge of the economy would be far better than the long run prediction made by any government. Thus, it makes sense for governments to focus on short run policies and maintain short run equilibrium. Keynes’ multiplier effect states that government spending would increase the GDP by a greater amount than the increase in government spending. This multiplier effect established a reason for governments to go for fiscal support when the economy requires it. What have been the criticisms of Keynesian economics? The initial stages of Keynesian economics propagated that monetary policy was ineffective and did not play any role in boosting economic growth. However, the positive effects of monetary policy are well established and have been integrated into the new Keynesian framework. Another criticism is that the advantage of the fiscal benefits to the GDP cannot be measured. Thus, it becomes difficult to fine-tune the fiscal policy to suit the economic scenario better. Also, the Keynesian belief of increased spending leading to economic growth may lead to the government investing in projects with a vested interest. It could also lead to increased corruption in the economy. The theory of rational expectations suggests that people understand that tax cuts are only temporary. Thus, they prefer to save up the income left behind to pay for future increases in taxes. This is the Ricardian Equivalence theory. Thus, fiscal policy may be rendered ineffective due to this. Supply-side economics has also shown contrast to Keynesian beliefs. During the stagflation in the 1970s, the Phillips curve failed, bringing out the importance of supply-side economics.
What is meant by deflation? Deflation refers to the fall in prices of goods and services in an economy. Deflation increases the purchasing power of a currency as goods become cheaper than usual. Deflation is the opposite of an inflationary scenario, where prices of goods and services in an economy rise. Deflation generally indicates a highly productive economy but decreasing prices could also point towards a contraction of demand. Deflation can also lead to a financial crisis as the prices could crash down to unforeseen levels. To some degree, deflation helps in increasing consumer spending, and it allows domestic consumers to purchase a higher quantity of products for the same price as before. On the contrary, deflation can sometimes be a sign of an impending recession. The speculation of an incoming recession may urge consumers to save more today, which can lead to a further contraction in demand. What are the causes of deflation? Two macroeconomic factors can cause deflation: Decline in Aggregate Demand: Aggregate demand (AD) refers to the total demand for all goods and services in a country. A drop in demand has a direct relation to an increase in prices. As demand falls, there is not enough consumption to meet the supply in the economy. Increase in Aggregate Supply: Aggregate supply (AS) refers to the total supply of goods and services available in a country. For the same reason as explained above, when the supply exceeds the demand, the prices decline. On a broader scale, deflation is caused by the disequilibrium in the AD-AS model. Deflation is the economic state where the money supply in the economy remains the same, but the population and the economy both expand. Therefore, to maintain equilibrium, the amount of cash in an individual’s portfolio decreases. This leads to an overall increase in the value of the currency, unlike in inflation. Deflation is the scarcity of hard cash in an economy which makes it more valuable to hold. The scenario of deflation can also occur when the productive efficiency of a nation increases due to better technology. Higher competitiveness levels also lead to firms lowering their prices as they save up on their costs. As prices are lowered, consumers are left with more cash in their portfolio, and thus deflation occurs. What are the economic impacts of deflation? Deflation can lead to the following macroeconomic impacts: Unemployment: As there is a lack of money in circulation, there is contracted demand. This may lead to producers further cutting down on their costs to save money. Thus, fewer workers are hired, and there are lesser jobs available. Debt: Interest rates increase under the scenario of deflation. Therefore, it becomes riskier to borrow as the interest to be paid on borrowings increases. This leads to the situation of debt deflation wherein the real value of debt rises due to deflation. Deflationary Spiral: This refers to the scenario where lower prices lead to a further drop in prices. As prices fall, companies try to save up on their costs, leading to lower production. As a result, lower salaries are offered to the employees, and they are not able to spend on consumption. This leads to a further contraction of the economy as the demand falls, which again deflates the price levels. Is deflation more harmful than inflation? Inflation leads to an overall increase in the price levels, and thus goods become more expensive, and the value of the domestic currency falls. However, inflation may be beneficial in some cases as it helps reduce the burden of international debt. As the domestic currency loses its value, the foreign debt on a country also declines in real terms. Unlike inflation, it is hard for consumers to protect themselves from deflation. People can invest and save enough money to ensure that they can combat the scenario of inflation. However, deflation poses a set of challenges for the consumers which are hard to get by and can be explosive at times. It can also put the economy under a liquidity trap, wherein people hoard money instead of investing it. How can deflation be controlled? Deflation can be controlled by the government using the following methods: Boosting money supply: Increasing the supply of money by buying back bonds through open market operations. This would increase the value of the currency, thus leading to increased public spending. Increasing borrowing: This can be done by lowering interest rates through monetary policy. As interest rates fall, people start borrowing, thus borrowed money is put into investments and the economy is revived again. Favourable fiscal policy: Along with monetary policy changes, the central bank can also boost public spending by introducing appropriate fiscal measures. This includes tax cuts, fiscal aids and increasing public expenditure. Is deflation overall a good economic scenario for a country? Deflation can be more harmful than beneficial for an economy. If a country finds itself locked into a deflationary spiral, it becomes challenging to come out of it. Moreover, increased debt levels caused by deflation are hard to recover from, even with proper debt financing measures taken by the government. Financing debt, in the current period, may lead to increased debt burden in the future. However, lower level of prices in an economy can also have positive connotations. It can be a sign of an efficient production set up in the economy facilitated by proper utilisation of resources. Economies that offer relatively cheaper goods are deemed to be highly competitive. An example is the computer hardware markets across the world. As new and fast production techniques become accessible across the globe, the price of the final output becomes lower internationally. Thus, there is deflation in the computer hardware markets.
What is Freudian Motivation Theory? Neurologist and psychoanalyst Sigmund Freud developed the Freudian theory of motivation. According to the theory, people’s choices are largely based on their unconscious behaviour. This means that people may seek motivation for buying certain goods through their unconscious channel of thinking. Individuals may not always fully understand why they make certain choices, since these are driven by their unconscious behaviour and not necessarily by wants or needs. This theory is frequently used in understanding consumer behaviour and in analysing the purchasing patterns of individuals. What are the components of Freudian motivation theory? According to Freud, the human psyche has two different parts: the conscious mind and the unconscious mind. Both these include three components in total: id, ego and superego. Id: According to Sigmund Freud, the id is the biological component of every individual’s thought process. Id includes instinctive senses that everyone holds since birth. It is the unconscious mind. Ego: Ego represents the conscious mind, and it is made up of thoughts, memories, feelings that individuals may base their decisions on. The ego gives a sense of personality to an individual. Superego: This includes society’s perceptions regarding ethics, values, taboos, etc. It is the moral branch that can influence how humans make decisions. This component shows that humans may not always act on impulse and is the “inner-voice” or conscience of humans. In some people id may be stronger; however, in others superego may be stronger. The relative strength of id, ego and superego determines how a human being takes decisions. Why is the Freudian motivation theory important? Freudian motivation theory can be applied in the fields of sales and marketing. The theory suggests that individuals may decide which products to buy based on their emotions and feelings, without consciously knowing it. Consider the example of a man who buys a new car given the fact that his old car is in good working condition. It is possible that the man’s decision to purchase a car was motivated by his urge to create a status symbol for himself in society. This decision may not be as conscious as the buyer would think it to be. To utilise the Freudian motivation theory's emotional standpoint, salespersons can incorporate specific marketing tactics that could trigger an emotional response from the customer, leading him to buy the product. Thus, motivation theory can help sellers achieve the desired response from the customers. How is the Freudian motivation theory applied? Corporations may reach out to motivation researchers who collect data from potential customers. The data is collected through interviews to understand the deeper motives behind buying a particular product. These researchers may use various techniques like word association, picture interpretation, sentence completion, role-playing, etc to understand how individuals make decisions. This information can enable marketing researchers to decide how these unconscious motivations can be best exploited to make the product lucrative to individuals. Freudian motivation theory states that the sale process has three parameters: Consumer satisfaction Functional needs satisfaction Unconscious needs What are some other theories of motivation? Apart from Freud’s theory of motivation, there are two other popular motivation theories. These include: Optimal-level Theory: This theory is also referred to as the theory of homeostasis, a term coined by French psychologist Claud Bernard. Homeostasis refers to the state of equilibrium in the body. This ideology belongs to the “hedonistic” theory, which states that happiness is the highest good. According to the hedonistic theory, there is an optimal level of normal functioning in every individual, allowing him to make the right decisions. However, if the individual were to fluctuate from this position to disequilibrium, he would not find it pleasurable. Thus, every human being strives to be in a state of equilibrium by maintaining an optimal level of needs like food, water, etc. Humanistic Theory: This theory believes in human beings' capacity to realise their own potential, strengthen their self-confidence, and achieve the ideal self. These can include biological factors like hunger, thirst; safety needs; love and belongingness need, esteem needs like respect and approval; self-actualisation motive like attaining maximum level of one’s capacities.