Efficiency and Market Equilibrium
In life, we all want to get the best from everything we do without having the spend too much. Both consumers and producers expect the market to be perfect so that demand and supply are all at the same level. This way, consumers will get enough goods while producers will make enough profit to incentivize the production of more goods and services. When the economy is good, it means everyone is happy, and every process has been perfectly measured and achieved. But then, economic cycles do not let the markets hit perfection, and both consumers and producers have to find a way to coexist.
There are two aspects of economic development that makes everything count. One is efficiency, and the other is equilibrium. In life, we are always faced by different situations that force us to make decisions. And there is no way anyone will live without having to make these decisions. There are many factors that influence these decisions, among the scarcity and budget constraints. According to consumer and producer theories, individuals and firms make decisions based on the best outcome. In other words, they are loss aversive, avoiding anything that seems to cause a loss for them.
And this is where efficiency and equilibrium. When companies want to introduce a new product on the market, they look at existing data to see whether or not consumers will like the product. Data is one of the most critical aspects of understanding and using economic theory. For instance, statistical information about a different company that has launched the same product in the past can help the firm decide on the best ways to succeed where others have failed. On the other hand, consumers use information like price and brand awareness of their buying decisions. But most importantly, they look at their budget and choose the decision of the most appropriate method. Take, for instance, a family that has been saving for a long time, and now they are held between the decision of buying a car or going on a dream vacation. It all comes down to the importance of consumer goods vs. luxury in their lives—the income of the decision-maker determines the utilization of either product.
Both firms and consumers require to make the right judgments and way carefully the outcome of their actions. Such decisions are better discarded if it leads to the harm of themselves or other people around them. It does not make sense for anyone to make a decision that causes a loss for them. It is like humanity to coexist and affect each other in everything they do. A single’ individual’s indecision to buy or not to buy a product will not majorly affect a company, but when a large group of people is involved, things may get worse or better for the markets. When one producer decides to raise the price of commodities, it may not have any major impact on the consumer as they can simply choose to go for another producer.
When looking at efficiency and equilibrium, we need to understand these factors because they are important in microeconomic theory. For instance, the mathematical approach to microeconomics demands the presentation of statistical data. If there is no data, then there is no mathematics because the subject deals widely with numbers and figures.
Now that we have laid the background for these subjects, we can get into their description and see their importance in economic processes. Efficiency means the highest level of performance whereby the involved party uses the least amount of inputs to achieve that highest output. It can be compared to the peak of an economic bubble, and that in this case, resources are directly involved. For efficiency to be counted, there must be a reduction in the number of unnecessary resources when producing a given output, and it may include personal time and energy. Efficiency is a measurable concept that be derived from the application of the ration of important output to total output. The main idea of efficiency is to minimize the wastage of resources and maximize profits. Things like physical material, energy, and time are cut down while ensuring the desired output is achieved. Efficiency is important because it helps both consumers and producers are benefiting from economic processes. When one buys a product, they put it to maximum use without risking loss. But it is within the company setting that we get to understand the real meaning of efficiency?
Generally, something is efficient when nothing goes to waste, and all the processes are fully optimized. In the fields of finance and economics, efficiency is very important because it used in a number of ways to get the most out of the process. It is critical for one to discern different terms used in efficiency. Consider the following:
- Economic efficiency.
This is efficiency in terms of individual decisions and processes. It is a form of optimization of resources to serve the best interests of an individual within an economic state. There are no set threshold determinants for the effectiveness of an economy. There is no telling how much a certain economy will succeed through economic cycles. However, the indicators of economic efficiency include products bought in to the market at the lowest cost and labor that offers the best possible outcome.
- Market efficiency.
Markets, too, have their share of economic ups are down. When a certain company makes decisions on a large scale, they generally affect what happens within that economy. And since firms make up markets, their decisions are essential in the growth of these markets. Market efficiency explains how well prices integrate available information. Hence, markets are considered to be efficient when all data and information are already included in the prices, meaning it is impossible to ‘beat’ the market as there is not any less valued securities are any that are overvalued within markets. Everything is said to be at the equilibrium with the market setting, with prices all at the same level. Economist Eugene Fama (1970) described market efficiency, where his efficient market hypothesis (EMH), says the investor cannot outperform the market, and market anomalies should not be there because they will be arbitraged with immediate effect.
- Operational efficiency.
This is the type of efficiency that measures how good profits are gained as a function of operating costs. Great efficiency means more profit for the firm, and vice versa. Companies need to make maximum profits through their operations, and they can do this by reducing costs. This happens especially because the entity can make more income or profits than if it used an alternative method. Operational efficiency is more critical and profound in financial markets, where it occurs with the reduction in transaction costs and fees.
There has been so much development in economic efficiency over the years. It has always existed coincidently with the invention of new tools that improve labor. These processes can be traced back to the ages of the wheel and horse-collar – the hoarse collar redistributes the weight on the back of a horse, helping the animal to carry more without feeling overburdened. The steam engines and motor vehicles came up during the industrial revolution, which allowed people to move further and faster, thus contributing to travel and trade efficiencies. More of these efficiencies were achieved during the Industrial Revolution, where the discovery of new power sources such as fossil fuels made processes cheaper, more effective, and versatile.
Even better, the Industrial Revolution and other movements that came after it brought efficiencies in time. For instance, the factory system introduced production lines where one participant focused on one area of specialization, which brought about an increase in production while saving time. At this time, many scientists came up and developed practices that would optimize specific task performance.
Why is efficiency important?
If a society is efficient, it will be able to serve its dweller and function in the best way possible. Economies need to have efficient processes so that the goods produced are sold at a lower price, enabling local consumers to enjoy better living standards. It is all about giving people a better life and ensuring the everyone withing an economy is having the best time of their lives. When people are supplied with electricity in their homes, running water in their taps, and they can travel easily, nothing will stop them from living their lives to the fullest. Efficiency brings down hunger levels as well as unemployment rates within a society. Advances in efficiency allow for greater productivity within a shorter amount of time, and use lesser resources, saving much for the future.
As we already know, all inputs are scarce. Human demands are unlimited and cannot be quenched by limited resources, which leads to great levels of scarcity. Time, money, and raw material do not exist in maximum fulness, and it is vital to conserve them while ensuring acceptable levels of output.
When it comes to understanding economics, one must be ready to learn and fully understand the concept of market equilibrium. This concept helps firms and individuals to make informed decisions whenever they are confronted by the need to do so – which happens at every turn. Markets are described as imperfect because there is no day production and supply will be on the same level. A perf market is where all factors are in perfect supply, including market information and data. But this only happens in theory.
However, this does not mean that firms and firms cannot achieve a state of equilibrium. There are certain situations that can be termed as good for the market. Equilibrium is a state where the supply within markets is equal to the demand. In this case, the equilibrium price is the price of a product when demand and supply are at the same level. Price does not change in an equal market unless other factors like demand and supply are changed, in which case it leads to the disruption of the equilibrium.
When markets fail to reach an equilibrium, forces with it tend to move towards the equilibrium line. This means, if the market price is above the equilibrium line, it means there is excess supply within the market – supply is higher than demand, an effect that leads to a surplus. Companies may not be able to clear inventories unless they apply specific strategies like reducing the price of their goods. Some situations may force them to slow down their production or cease ordering inventory. As long as price keeping reducing, people will keep buying, and it may continue so until supply is further reduced. While supply reducing, demand, on the other hand, will be increasing.
In a situation where the market price is below the equilibrium, it means demand is in plenty and supply in shortage. This case compels buyers to bid up the price of goods and serves so that they can get them. As prices increase, buyers will quit trying, not because they don’t want to, but because of the scarcity of cash and budget constraints. Apart from this, sellers will be excited to see a surge in demand and want to produce more of the product. This condition may continue until the upward pressure on prices and supply stabilize – a market equilibrium.
Determining market equilibrium is one of the best ways to understand economic prices. Fortunately, it is very easy as long as you have the required sets of data. Let’s say, for instance, you are and economist working with a Global Economy Agency, and you are tasked to study the market of peaches in Congo, a developing economy. You have received transaction data for this factor from the past two years, which shows the government has incentivized farmers to grow more Peaches, and now they are seeking to attract international investors. You can allow your team to create a Supply and Demand Equation where:
P is the price per container of the product.
Supply X = 300 + 3p
Demand X = 1,800 – 2p
You can use this information to fine Q by balancing them.
300 + 3p = 1800 – 2p
Hence, 300 + 3p + 2p = 1800
Working further, we get 300 + 5p = 1,800, and then 5p = 1800 – 300
Therefore, 5p = 1,200
Let’s say P = $300, then
Supply Q = 300 + 3 x 300 = 1200.
Author: James Hamilton