Welcome back, my fellow Earth economist's! Last time we already studied the equilibrium of supply and demand. Equilibrium and disequilibrium are important concepts in economics, and a sound grasp of this concept is important. So this is why we will discuss this key concept in more detail. Now you may think that an equilibrium is always good, but you will learn that we have different kinds of equilibria, and that some equilibria are good, but others are bad. If an equilibrium is good, then you can relax, but if an equilibrium is bad, you need to find ways to escape from that equilibrium. An equilibrium is a situation in which there is no tendency for change in the situation. This requires that all competing forces are balanced. In economics, this occurs when all plans of persons and firms are realized. Now what happens if something changes? For economists, this amounts to asking the question, how does an economy react if it is hit by a shock? Such disturbances can occur in the real world. For example, if wars or epidemics breakout or due to new technologies. Shocks also occur in the minds of people. For example, during bank runs or when optimism rules the world. A temporary disturbance will move the economy out of the equilibrium. If the economy returns to the equilibrium, then the system is stable. If not, the system is unstable. From a policy perspective, uncontrollable economic variables create enormous difficulties. An example is hyper-inflation, when prices increase almost on an hourly basis. I'm struck by this banknote. It shows a stable construction, but it represents 100 trillion. When we will discuss government, we will find that global debt increased from 15% of GPP in 1970, to more than 80% today. Now, for me, the most worrying case is global warming. I think it is closely linked to the level of greenhouse gases. For the survival of humanity, it is vital to check global CO2 emissions. Do environmental policies ensure stability? Or will the system explode? Now you see the importance and relevance of the stability properties of Earth's economy. So what is stability? If a temporary disturbance sets in motion movements away from the original point, the equilibrium is called unstable. Give the skateboarder push and he falls. In a stable equilibrium, a temporary shock to the system will result in a temporary deviation from the equilibrium, and eventually the system returns to the starting point. The half-pipe is a stable equilibrium. Everything ends at the bottom. Three lessons. First, arrows that point away from the equilibrium indicate instability. The opposite holds for stability, and finally, an equilibrium can be mixed. In a stable equilibrium, the ball always ends up at the bottom of the valley. The equilibrium is locally stable, because it starts in equilibrium and if no shock occurs, the ball will stay where it is. It is also globally stable because after a shock, it will in the end returned to its original position. Why is this different from the situation on the right-hand side? The equilibrium is stable at the beginning and the end, but the equilibrium levels differ. The situation in the middle is an unstable equilibrium. It is an equilibrium, the ball is stable and lying on top of the hill. However, once disturbed the ball will roll down and never return to the original position. This equilibrium is locally stable but globally unstable. Hyper-inflation, global warming, and debt explosions are potentially different. The ball on the top of the hill will eventually stop rolling when it reaches the bottom of the valley or a plane. But what if it continues running and running? Let's now take a look at one of the most worrisome global trends, Earth's population explosion. The left-hand graph starts 10,000 years Before Christ. For more than 11 millennia, world population stayed well below 1 billion people. But the last century saw an increase by 6 billion people. Yes, I am always shocked when I realize that population increased four fold since I was born. The right-hand graph indicates continued explosive exponential population growth. The forecasts for the rest of our century are more optimistic and show that growth levels of. If this is the case, then the predicted 11 billion earthlings could be considered to represent a stable population equilibrium. Now ask yourself this question, is the stable population at the end of the century a good or a bad equilibrium? Did you come up with an answer? You will have noted that an answer requires judgment. This is not a question that fits easy in the boxes of either good or bad. I am happy about eventual stabilization of population growth, but I truly believe this is an equilibrium for which we should try to escape. Population size is one of the root causes of Earth's problems. Scarcity, environmental degradation, hunger, and global warming require less, not more earthlings. Easy solutions do not exist, and many moral dilemmas appear on the horizon. This is an issue that needs to be addressed. How can we move Earth's economy from a bad equilibrium to good equilibrium? When economists want to answer a question like this, they use the method of comparative statics. The basic idea is to compare two equilibria of an economy. One equilibrium before and and one after the shock has worked its full way through economic system. This is a useful assumption if you want to avoid complex computations, but it carries an important analytical and policy relevant cost, because it ignores how one moves from one equilibrium to another. Perhaps you think that this does not matter and that the shortest distance is always the best, but that is not the case, and often the detour is more efficient. So the adjusted path of an economy matters a lot. Often, a movement to a new equilibrium entails adjustment costs. Typically, these are the upfront costs of policy change. A change of policy creates unemployment where old jobs are lost while new jobs are still to be created. Structural changes will require people to move to other of professions and occupations. Now comparative statics hides these costs. It will therefore be important to analyze more than the equilibrium of an economy. Professor Peter. Do we have an alternative to comparative statics? Yes. As we will see later, we can explicitly study the dynamics of economics. I was also thinking about alternatives to modeling, that could help us to see the journey of particularly economy. A good alternative can be scenario analysis, and today's readings are providing an introduction.
