Question

“Market-clearing” is a key assumption underlying the Neoclassical Theory of Distribution. What exactly does this “market-clearing” assumption mean? When might we expect it to be a plausible assumption, and when would it be less plausible?

Answer 1

Equilibrium price is also called market clearing price because at this price the exact quantity that producers take to market will be bought by consumers, and there will be nothing ‘left over’. This is efficient because there is neither an excess of supply and wasted output, nor a shortage – the market clears efficiently. This is a central feature of the price mechanism, and one of its significant benefits.

Example

The weekly demand and supply schedule for a brand of soft drink at various prices (between 30p and £1.10p) is shown opposite.

The new classical economicsassumes that, in any given market, assuming that all buyers and sellers have access to information and that there is not "friction" impeding price changes, prices always adjust up or down to ensure market clearing.

However, according to keynes prices are sticky.Price Stickiness is the resistance of aprice (or set of prices) to change, despite changes in the broad economy that suggest a different price is optimal. "Sticky" is a general economics term that can apply to any financial variable that is resistant to change. When the prices are sticky, the market clearing mechanism fails .