Causes of Disequilibrium in the economy

Causes of Disequilibrium in the economy Economists usually define general disequilibrium as the state in which contrasting market forces of supply and demand fail to reach a balance and there exist an intrinsic inclination for change. The main indicator of market disequilibrium is the continuation of shortages either in the demand or supply side of the economy. There are two main models that hold divergent views concerning disequilibrium namely the classical and Keynesian models   [ 1 ]   . Causes of disequilibrium Generally, the major causes for disequilibrium in the markets if the deficiencies created either in the aggregate demand or aggregate supply side of the economy. This means that in such circumstances the market does not clear. Main causes of disequilibrium are understood in the light of the economic model s followed by scholars. For instance, the Keynesian theory’s causes differ from that of classical economists. For instance, following Keynesians’ view, disequilibrium arises when there are di sparities between leakages and injections where as classical economists argue that if such cases arise, price always adjust to bring the economy back to equilibrium.   [ 2 ]    In the above diagram, equilibrium occurs at point P2-Q2 where AD2= AS. At that point, the economy is at full employment. Below this point the economy is in disequilibrium whereby it is operating below full employment. Keynesian theory’s view s about disequilibrium Keynesian theory is the widely used model that explains the general equilibrium using the IS-LM model. Keynesian model construe that markets may not be self-adjusting therefore the markets would not lead to full employment equilibrium if the economy is left to self-regulate. Keynes used the income-expenditure theory to explain the concept of disequilibrium and full employments. He came up with a detailed analysis of the functions of money, functions of interest rates as well as the aspect of relative prices. Keynesian theory postulates th at equilibrium usually occurs below the full employment level. Keynes argued that constant equilibrium cannot prevail due to the existence of involuntary unemployment.   [ 3 ]    In the commodity markets, Keynesians clearly outlines the major disparities that usually reinforce a state of disequilibrium. They compare the aggregate expenditure which includes household consumption, investment function as well as government spending with the effective demand. They postulate that when the economy operates below the intersection of the two, it means there is an imbalance/disequilibrium.   [ 4 ]    Keynesians denied the supply side of the classical economists. Keynes stated that firms should be given the supply schedule so that they can demand smaller amounts than the existing national demand schedule. Keynes explained the causes of disparities in supply and demand separately. According to him, supply creates income. He postulated that what people produce is the one which is bought therefore supply’s value at all times equals the income value. The income is spent by the earners in consumption of more goods. Keynesian economists advocate an increase in government spending when the economy is below full employment in order to stimulate the economy.   [ 5 ]    Classical economists Classical economists holds the notion that markets are self regulatory which is opposite of Keynesian views. They construe that whenever disequilibrium state occurs between the leakages and the injections, prices usually adjusts to re-establish the general equilibrium. They held assumption that there prices are flexible savings are equal to investments as well as embracing the say’s law which states that supply creates its own demand. Explaining the aspect of disequilibrium through say’s law, classical theorists construe that aggregate production in the economy have to create sufficient income that to buy all units of income, failure to which disequilibrium occ ur.   [ 6 ]