What is market equilibrium?

What is market equilibrium?

Market Equilibrium occurs when fluctuations between supply and demand balance out, keeping prices relatively stable. This trend appears relatively horizontal or sideways when charted. Both price equilibrium and quantity equilibrium should meet at the same point where the supply and demand curves meet on a chart.

According to the Law of Supply, with all factors being equal, if the price of a good or service increases, the supply of that good or service will increase. If demand doesn't meet it, the price of that good or service must come down; this increases demand but might cause a shortage in supply, which might drive prices back up, and so on.

When the Supply Curve is plotted on a graph, the y-axis typically measures price, while the x-axis denotes quantity. If the relationship between price and quantity is positive, the line will climb to the right. The opposite direction is the Demand Curve, and the place where the two intersect is considered to be the point of market equilibrium. The curves can be shifted by variables not present on the graph, such as changes in levels of income and other factors, but the slopes will theoretically remain the same.

Market efficiency is maximized at equilibrium. The Efficient Market Hypothesis states that random new information will affect the value of securities, and that new information disseminates so quickly among rational investors that it is futile to try to beat the “market portfolio.”

Thirty years ago, this was more of a theory than an observable phenomenon, and plenty of inefficiencies in the dissemination of information and the pricing of securities could be pointed out. But today, computers disseminate information far more quickly than before; coupled with higher numbers of active investors, something close to market efficiency is far more obtainable than ever before.

While today’s markets may be more efficient than ever before, there will always be short-term trading opportunities that capitalize on various situations. Emerging markets will likely continue to exist, and active managers who find and exploit inefficiencies in this space tend to outperform an index for such a market. Artificial intelligence technology can further help traders identify and execute trades based on advantageous parameters, even as markets become more efficient as a whole.