What is imbalance?

Imbalance is a situation where internal and / or external forces prevent market equilibrium from being reached or cause a market imbalance. This can be a short-term by-product of a change in variable factors or the result of long-term structural imbalances.

The imbalance is also used to describe a country’s deficit or surplus in the balance of payments.

Key points to remember

  • Imbalance occurs when external forces upset the balance between supply and demand in a market. In response, the market enters a state where supply and demand are incompatible.
  • The imbalance is due to several reasons, from government intervention to the ineffectiveness of the labor market and the unilateral action of a supplier or distributor.
  • The imbalance is usually resolved by entering the market into a new state of equilibrium.

Understanding the imbalance

A market in equilibrium is supposed to function efficiently because its quantity supplied is equal to its quantity demanded at an equilibrium price or at a market compensation price. In a balanced market, there is neither surplus nor shortage for a good or a service. Looking at the graph of the wheat market below, the price at Pe is the single price that encourages farmers (or suppliers) and consumers to engage in an exchange. In Pe, there is a balance between supply and demand for wheat.

Image of Julie Bang © Owner Investopedia 2019

Sometimes certain forces cause the price of a good or service to move. When this happens, the proportion of goods supplied compared to the proportion demanded becomes unbalanced and the market for the product is said to be unbalanced. This theory was originally put forward by economist John Maynard Keynes. Many modern economists have compared the term “general imbalance” to describe the state of the markets as we find them most often. Keynes noted that markets will more often than not be in some form of imbalance — there are so many variable factors affecting financial markets today that true balance is more of an idea.

According to our graph for the wheat market, if prices went up to P2, suppliers would be willing to supply more wheat from their storage barns for sale on the market, since the higher price would cover their production costs and lead to higher profits. However, consumers can reduce the amount of wheat they buy, given the higher market price. When this imbalance occurs, the quantity supplied will be greater than the quantity requested and a surplus will exist, causing an imbalance in the market. The excess in the graph is represented by the difference between Q2 and Q1, where Q2 is the quantity supplied and Q1 is the quantity requested. Given the surplus merchandise supplied, the suppliers will want to sell the wheat quickly before it is rancid and will reduce the selling price. Economic theory suggests that in a free market, the market price for wheat will eventually fall to Pe if the market is left to function without any interference.

What if the market price for wheat was P1. At this price, consumers are ready to buy more (T2) wheat at a lower price. On the other hand, since the price is lower than the equilibrium price, suppliers will supply a smaller quantity of wheat (T1) for sale because the price may be too low to cover their marginal costs of production. In this case, when Pe falls to P1, there will be a shortage of wheat because the quantity demanded exceeds the quantity supplied for the product. As resources are not allocated efficiently, the market would be out of balance. In a free market, the price is expected to increase up to the equilibrium price because the scarcity of the good forces the price to rise.

Reasons for imbalance

There are several reasons for the market imbalance. Sometimes an imbalance occurs when a supplier sets a fixed price for a good or service for a certain period. During this period of sticky prices, if the quantity demanded increases in the market for the good or service, there will be a shortage of supply.

Another reason for the imbalance is government intervention. If the government sets a floor or ceiling for a good or service, the market can become ineffective if the quantity supplied is disproportionate to the quantity demanded. For example, if the government sets a ceiling price for rent, owners may be reluctant to rent their additional property to tenants, and there will be excessive demand for housing due to the shortage of rental housing.

From an economic point of view, an imbalance can occur in the labor market. A labor market imbalance can occur when the government sets a minimum wage, that is, a floor price on the wages that an employer can pay its employees. If the stipulated floor price is higher than the equilibrium price of labor, there will be an excess supply of labor in the economy.

When a country’s current account is in deficit or in surplus, its balance of payments (BoP) would be out of balance. A country’s balance of payments is a record of all transactions with other countries during a given period. Its imports and exports of goods are recorded in the Current Account section of the balance of payments. A large current account deficit where imports exceed exports would cause an imbalance. The United States, the United Kingdom and Canada have large current account deficits. Likewise, when exports exceed imports, creating a current account surplus, there is an imbalance. China, Germany and Japan have large current account surpluses.

A balance of payments imbalance can occur if there is an imbalance between domestic savings and domestic investment. A current account deficit will occur if domestic investment exceeds domestic savings, since excess investment will be financed by capital from foreign sources. In addition, when the trade agreement between two countries affects the level of import or export activities, a balance of payments imbalance arises. In addition, changes in an exchange rate when a country’s currency is revalued or devalued can cause an imbalance. Other factors that could lead to an imbalance include inflation or deflation, changes in foreign exchange reserves, population growth and political instability.

How is the imbalance resolved?

The imbalance is the result of a mismatch between the market forces of supply and demand. The mismatch is usually resolved by market forces or government intervention.

In the example of the shortage of the labor market above, the situation of excess labor supply can be corrected either by policy proposals addressed to the unemployed, or by a process of investment in training workers to make them suitable for new jobs. In a market, innovations in manufacturing or the supply chain or technology can help bridge imbalances between supply and demand.

For example, suppose that the demand for a company’s product has decreased due to its high price. The company can regain its market share by innovating its manufacturing or supply chain processes for a lower product price. The new equilibrium, however, could be one where the firm has a greater supply of its product in the market at a lower price.

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