There is no equilibrium position in economic activity


7. There is no equilibrium position in economic activity.

Economists used to talk, and some still do, of the equilibrium position at which supply meets demand. Demand generally decreases as price rises, while more suppliers will tend to enter the market as prices rise. The equilibrium price is supposed to the price at which the supply exactly matches the demand. People use this (and other) 'equilibrium' notions to derive equations which aim to describe how an economy behaves.

The problem is that equilibria are entirely theoretical abstractions and do not occur in real economies. The real economy is characterized by motion. There never is a point at which supply meets demand. Demand changes from moment to moment, and so does supply. There are countless economic actions taking place every moment as potential consumers change their positions on whether they are in the market for particular items, and potential producers decide whether or not to put more produce on sale. Even further back, producers are deciding whether to commit resources now to augment production in a few months time, in anticipation of what demand might be.

At no point does the economy stop and allow itself to be examined. To study a frozen moment of it would be like trying to study a motionless human body. The body is constantly in motion taking air in and out, pulsing blood through veins and arteries, and sending neurons between cells. To study it at rest is to miss the whole point of it, its motion. Even a body at apparent rest is a mass of motion as information crosses between brain cells. The economy is characterized by constant change as it responds to the inputs of countless individuals. People do not respond to abstract economic equilibria; they respond to the changes actually taking place in front of them in the real economy, and their behaviour cannot be abstracted and studied as if it were a response to stationary conditions.

Inconveniently for econometricians, the numbers which describe an economy are changing from moment to moment, and equations which work with particular values can lose sight of the economy's most salient characteristic: it is a process.

Attempts have been made to bypass these drawbacks by using Dynamic Stochastic General Equilibrium (DSGE) models which try to factor in the preferences of the participants, and to account for random shocks to the economy. They attempt dynamic modeling, but face the problem that real economies develop in non-linear ways, and that people's behaviour changes in response to inherently unpredictable events.

This is part of Dr Pirie's ongoing series: Philosophical Observations on Economics.