March 23, 2018 

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LOCATION THEORY: A theoretical framework for studying the location decisions made of firms and households based on transportation cost and spatial differences in the accessibility of inputs and markets for outputs. Location theory, developed with noted contributions from August Losch, Alfred Weber, Johann von Thunen, Walter Christaller, and Walter Isard, explicitly considers the cost of transportation in the production and consumption choices made by firms and households. Location theory has been used to explain urban density, labor migration, and land use.

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Equilibrium that is not restored if disrupted by an external force. Few economic models have an equilibrium that is unstable, reflecting the observation that the real world adapts to changes and maintains a fair degree of stability. However, there are situations where an unstable equilibrium more accurately reflects economic phenomena. The alternative to an unstable equilibrium is a stable equilibrium.
An unstable equilibrium exists if a model or system does not gravitate back to equilibrium after it is shocked. The analogy is much like a marble resting on top of an upside-down bowl. Should the marble be nudged a bit, then it roles off the bowl and down the side. It does not return to its position of rest, but moves away.

While market equilibrium is a common example of a stable equilibrium, in which equilibrium is restored, consider what a market would be like with an unstable equilibrium.

The process would work like this:

  • A demand determinant or supply determinant changes, which shifts the corresponding demand or supply curve.

  • This change then disrupts the equilibrium, creating either a shortage or surplus.

  • Prompted by the imbalance in the market, the price changes, which causes changes in quantity demanded and quantity supplied.

  • The key to an unstable equilibrium is the quantity changes act to increase, rather than reduce, the shortage or surplus. As such, the equilibrium balance in the market is not restored.
What makes this an unstable equilibrium is that balance is not restored through the fundamental workings of the market. In particular, the price changes in the wrong direction than what is needed to eliminate the shortage or surplus.
  • Shortage: A shortage arises if the market price is below the equilibrium price. The quantity demanded exceeds the quantity supplied. An unstable equilibrium exists if the shortage prompts the price to fall rather than rise. A lower price causes an increase in the quantity demanded (according to the law of demand) and a decrease in the quantity supplied (according to the law of supply). Both changes in quantity act to increase the shortage and move the market away from equilibrium.

  • Surplus: A surplus arises if the market price is above the equilibrium price. The quantity supplied exceeds the quantity demanded. An unstable equilibrium exists if the surplus prompts the price to rise rather than fall. A higher price causes a decrease in the quantity demanded (according to the law of demand) and an increase in the quantity supplied (according to the law of supply). Both changes in quantity act to increase the surplus and move the market away from equilibrium.
While the real world appears to be best characterized primarily by stable equilibrium, a few examples suggesting the existence of unstable equilibrium can be found. Business-cycle contractions, stock market crashes, full-blow economic depressions, and boom-town growth are probably examples.

The word "probably" is used because it is not always evident whether or not these phenomena are caused by an external disruption that induces the adjustment from one equilibrium to another (which would be stable), or by a chaotic movement away from an equilibrium (which would be unstable).

There is evidence to suggest that some sudden economic downturns and explosive growth, especially in small communities, reflect the workings of an unstable equilibrium. In situations like this, it appears that the fundamental workings of the economy might be moving farther from, rather than closer to, equilibrium. That is, the events that create the imbalance are then compounded by the imbalance, at least for brief periods.


Recommended Citation:

UNSTABLE EQUILIBRIUM, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: March 23, 2018].

Check Out These Related Terms...

     | stable equilibrium | equilibrium | market equilibrium | equilibrium price | equilibrium quantity |

Or For A Little Background...

     | equilibrium | demand determinant | supply determinant | demand curve | supply curve | law of supply | law of supply | ceteris paribus |

And For Further Study...

     | comparative statics | shortage | surplus | invisible hand | self correction, market | graphical analysis, market equilibrium | market disequilibrium | invisible hand | market clearing | competitive market |

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