“Even if the supply curve slopes downward, as long as it cuts through the demand curve from above, the equilibrium will be stable” For the very basic Supply and Demand curve (that looks like X), supply curve actually cuts through the demand curve from bottom. But the book says it is still stable. Will someone please explain why?
Here the book is explaining situation where there are two equilibrium point
The question is: Do market forces in an unstable state drive to or away from stable equilibrium? Take the basic Supply and Demand curve, said X. Let’s say we have an unstable state above the stable equilibrium (upper part of the X). Here we have excess supply (draw a horizontal line -representing a fixed price- and you will see that the intersect of the horizontal line with the supply curve is further to the right than the demand curve). Excess supply leads to an increase in price, so downwards. Downwards to the equilibrium. Now let’s assume another unstable state in the lower part of the X. Here we have excess demand. Excess demand increases prices, so we have upward forces… leading to the equilibrium. To sum up: In any state above equilibrium, market forces drive prices downwards, in any state below equilibrium, market prices drive prices upward. Market forces always push towards equilibrium. That means, we have a stable equilibrium. Let’s focus on unstable equilibria: Again, take our basic system with the X, but change the supply with demand curve, so that the upward sloping curve now is demand, downward sloping is supply. In any state in the upper part of the X (above equilibrium) we have excess demand. Excess demand leads to price increases, so we move further upwards, aka “away from equilibrium”. In an state in the lower part of the X (below equilibrium) we have excess supply. Excess supply leads to price decreases, so we move further downwards, aka “away from equilibrium”. To sum up: As soon as we move away from the equilibrium, market forces will drive us away from the equilibrium. That means, we an unstable equilibrium. Unfortunately it is not that easy to explain these mechanisms just using words, it is much easier to just draw the stuff and check it out…