Stability of the Equilibrium: 2 Approaches | Microeconomics

This article enumerates the two approaches of the stability equilibrium. The approaches are: 1. Walrasian Approach 2. Marshallian Approach.

1. Walrasian Approach:

The Walrasian approach is based on the behavioural assumption that in response to excess demand for output sellers will raise the price of the commodity under consideration. And in the opposite case sellers will lower the price of the commodity. Let the market demand function be p = D(q) and the market supply function be p = S(q).

The market equilibrium is stable in the Walrasian sense if price rise leads to a fall in excess demand for output. We can analyse Walrasian stability under various assumptions about market supply curve. The market demand curve is normally assumed to be downward sloping.

Case I: Normal Situation:

Let the market demand curve be downward sloping as usual and the market supply curve be upward sloping. In Fig. 2.6 the current price is P₁. At this price there is excess demand of AB. This Equilibrium excess demand is a reflection of shortage of output. This will induce the sellers to raise the price of the product. Price will continue to rise until excess demand is eliminated and the market is at point E. So the market equilibrium is stable.

Case II: Decreasing Cost Industry:

In a decreasing cost competitive industry the supply curve SS is downward sloping.

In this case we may face two different situations:

(a) The market supply curve is steeper than the market demand curve.

(b) The market demand curve is steeper than the market supply curve.

Suppose the current market price is OP₁ in Fig. 2.7. At this price AB is the excess demand for output. As before excess demand will push the price up. Price will continue to rise until we reach market equilibrium at E. So equilibrium is stable in the Walrasian sense.

In Fig. 2.8 the market demand curve is steeper than the market supply curve. At current price OP₁ there is an excess supply of AB. Excess supply is a reflection of overproduction. This will induce the producers to decrease the market price. As price falls the market deviates away from equilibrium. So the equilibrium is unstable in the Walrasian sense.

2. Marshallian Approach:

Unlike the Walrasian stability analysis which focuses on price adjustment to bring about equilibrium, the Marshallian approach stresses quantity adjustment to ensure equilibrium. The Marshallian approach is based on the behavioural assumption that sellers will increase the quantity of output in response to excess demand price and they will decrease the quantity in response to excess supply price.

The demand price refers to the maximum amount that the buyers are willing to pay for a given output and the supply price shows the minimum unit price that must be paid by consumers for a given quantity of output. So equilibrium is stable in the Marshallian sense if the increase in output in response to excess demand price decreases the magnitude of excess demand.

Case I: Stable Equilibrium:

Here we assume that the market demand curve is downward sloping and the market supply curve is upward sloping. Let us suppose the quantity of output offered for sale in the market is 0Q₁. At this quantity demand price is P_d and supply price is P_s. Since P_d is greater than P_s there is excess demand price (when the actual quantity is 0Q₁).

In response to excess demand price sellers will increase the quantity of output. As output rises demand price falls from P_d to P₀ along the AE segment of the demand curve and the supply price rises from P_s to P₀ along the BE segment of the supply curve. This is how the market equilibrium is restored at E. In this case equilibrium is stable in the Marshallian sense.

Case II: Both Stable and Unstable Equilibria:

Equilibria are both stable and unstable in the Marshallian sense in a decreasing cost industry.

Here we consider two cases:

(a) The market demand curve is steeper than the market supply curve as shown in Fig. 2.10. Let us suppose the quantity of output offered for sale in the market is 0Q₁ and at this quantity P_d > P_s. This implies that producers will respond to excess demand price by increasing their output. As the quantity supplied rises the market converges towards equilibrium at E. Thus equilibrium is stable in the Marshallian sense.

(b) The market supply curve is steeper than the market demand curve as shown in Fig 2.11. Let us suppose the quantity of output offered for sale is 0Q₁ and at this output P_d > P_s. Now in response to excess demand price sellers will increase their output above 0Q₁. As output rises the market deviates further and further away from equilibrium. Thus equilibrium is unstable in the Marshallian sense.