Question

How can equilibrium be unstable in an economy?

Answer 1

Equilibrium can be unstable anytime the conditions impacting either supply or demand (or both) are shifting.

Explanation:

Equilibrium is tricky, because the concept implies stability. However, it might help to think of equilibrium more as a tendency than as a steady-state condition. Equilibrium exists if none of the underlying factors change for supply and demand -- but this is never technically true! Lots of factors could cause either supply or demand to shift. Anytime one of these factors changes, the equilibrium price and quantity would change (ignoring the possibility of perfectly elastic or perfectly inelastic curves). Each of the price-quantity pairs represents a different equilibrium.

Of course, breaking down equilibrium at too fine a level of detail starts to get confusing, so it might also help to ignore small changes and just try to explain large changes as a result of a shift of either supply or demand.

For example, housing prices in Colorado have increased by a bit more than 10% in the past year (significantly more in some neighborhoods). Lots of different factors have changed, but the most noticeable factor seems to be consumer confidence. People who were reluctant to buy houses during the recession (or people who lost their jobs and homes) are feeling more confident, and unemployment is down. These factors have shifted demand, and as a result the quantity and price have both increased.

This explanation of the housing market is a deliberate over-simplification -- as most supply-demand explanations are. Many other factors are shifting, daily. But, the big-picture explanation still seems to capture the most important of the changes.