Equilibrium, what equilibrium?

Economists build models to analyze stylized facts. In the end, we all want to discuss the state of equilibrium. In the case of basic supply and demand analysis, we say the market clears at equilibrium. If the market is in dis-equilibrium, there will be either excess supply or excess demand. Then the system is said to be in transition to a new equilibrium with a new clearing price.

The problem is, how do we know the prices we observe are in equilibrium or in transition? A Saudi Arabic prince once famously denounced the crude oil shortage, "what shortage? Buyers still can buy any oil they want. "(not exact words) That is very true in a way.

In a bazaar, we know supply and demand are in dis-equilibrium if there is a line waiting to get something tasty. Demand exceeds supply. In a more abstract scenario, we also can discern dis-equilibrium. Suppose a bigger kid bullies a smaller kid all the time. The stronger extorts money from the weak. If the extorter continuously increases the level of the bullying, it can't be in equilibrium. No one kid can sustain bullying for a long period of time, especially when he apparently does not have an unlimited credit line. Something terrible is bound to happen if no one intervenes.

Unfortunately, those are exceptions rather than the rule. It is very difficult for us to distinguish equilibrium from transition in economics. Prof. Dooley said it frankly, "we don't know if the system is in equilibrium unless we have the models in mind." It was a hard concept to absorb at first. In fact, I believe all of us were very shocked to learn this in his advanced international finance class. What he said was counter to not only what we have learned but also what we have been teaching! We talk about the equlibrium like it is something we feel and touch easily and frequently. And yet it isn't something you can point it out every time you see it. Think about these: is the Dow Jones approaching 13,000 an equlibrium? is the water level at Lexington Reservoir now an equlibrium? We don't know! By the end of the class, I was totally sold at this idea. I guess I am at a new equilibrium now.

(Picture: University of Texas)