Tatonnement process

3 key takeaways

• The tatonnement process is a theoretical method of finding market equilibrium through iterative price adjustments.
• It involves continuously adjusting prices based on excess supply and demand until an equilibrium is reached.
• Understanding the tatonnement process helps in analyzing how markets move toward equilibrium and the stability of economic systems.

What is the tatonnement process?

The tatonnement process, a term originating from the French word for “groping” or “trial and error,” is an economic concept describing how prices adjust in response to excess supply and demand in a market. This theoretical process, introduced by economist Léon Walras, explains how markets can find equilibrium where the quantity supplied equals the quantity demanded through a series of gradual price changes.

In the tatonnement process, no actual trades occur until equilibrium prices are reached. Instead, hypothetical price adjustments are made based on observed imbalances in supply and demand. This iterative process continues until the market clears, meaning all goods supplied are purchased, and there are no excesses or shortages.

How does the tatonnement process work?

• Initial price setting: The process begins with an initial set of prices for goods and services in the market.
• Observation of excess supply and demand: At these initial prices, the quantities supplied and demanded are observed. If there is an excess supply (more goods are available than demanded), prices need to decrease. Conversely, if there is an excess demand (more goods are demanded than available), prices need to increase.
• Price adjustment: Prices are adjusted incrementally in response to the observed excess supply or demand. If there is excess supply, prices are lowered to encourage more consumption and less production. If there is excess demand, prices are raised to encourage more production and less consumption.
• Iteration: The process repeats, with continuous observation and adjustment of prices, moving closer to equilibrium with each iteration.
• Equilibrium: The process stops when prices reach a level where the quantity supplied equals the quantity demanded, achieving market equilibrium.

Examples of tatonnement process

• Commodity markets: In markets for commodities like oil or wheat, prices adjust based on global supply and demand conditions. If there is a surplus of oil, prices drop until demand rises to absorb the excess supply, reaching a new equilibrium price.
• Stock markets: Stock prices adjust based on buying and selling pressures. If a stock is in high demand and its price rises, sellers are incentivized to sell, increasing supply until the market finds a balance between buyers and sellers.
• Housing market: Housing prices adjust based on the balance between the number of homes available and the number of buyers. Prices rise in response to high demand and fall when there are more homes than buyers, aiming for a point where supply meets demand.

Understanding the tatonnement process is important for comprehending how markets move toward equilibrium and how prices can signal changes in supply and demand. While it is a theoretical concept, it provides insights into the dynamic nature of markets and the mechanisms that drive price adjustments and market stability. For further exploration, consider studying models of general equilibrium and the application of tatonnement in various economic contexts.