Edited by Mark Blaug and Peter Lloyd
Chapter 2: The Stability of Equilibrium
Mark Blaug By stability, economists basically mean the question of whether the relevant variables in some economic model converge to an equilibrium value over time. Much of economic theory depends on the comparative statics of equilibrium positions and comparing equilibria makes sense only if the underlying system is stable. Consider, for example, an elementary demand and supply model. How are we to explain the change in the price of strawberries that occurs every winter when the temperature plummets? The answer, based on the familiar cross diagram of Figure 2.1, is that the price will increase because the cold weather decreases the quantity supplied of strawberries (shifts the supply curve to the left). This comparative statics explanation depends on the stability of the underlying equilibrium. For instance, consider the case depicted in Figure 2.3. In this case, the equilibrium price is p* but the market is unstable: for any price above p*, there is positive excess demand or a shortage, and thus competition on the demand side will bid the price up, away from p*1. Similarly, for prices below p*, competition on the supply side will cause the price to fall, again moving away from p*. For a market like the one shown in Figure 2.3, a reduction in supply will cause the price to fall, not rise, and thus the lower equilibrium price will never be reached after the change in supply. If the supply is reduced in such a market, there will be excess demand at the old...
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