Final answer:
Markets may exhibit short-term volatility but tend to reach equilibrium in the long term. Equilibrium is affected by supply and demand, with examples seen in bull and bear markets as well as foreign exchange markets reacting to interest rate changes. Supply-side considerations highlight that production expansion facilitates market equilibrium, but typically over several years.
Step-by-step explanation:
The effectiveness of markets in reaching equilibrium can be gauged by their ability to balance supply and demand factors over different time frames. In the short term, markets may experience volatility and may not always reflect true value or equilibrium due to various external factors such as geopolitical events, policy changes, or investor sentiment. However, in the long term, markets have a tendency to correct themselves, guided by the underlying economic fundamentals. Bull markets indicate periods of rising market values, as seen when the DJIA broke the 4000 mark in 1995 and reached 12,000 by 2000. Conversely, bear markets reflect downturns, like the 1200-point drop from the 9,000 peak in 1998. These cycles are part of the market's natural process to reach a new equilibrium.
Considering the foreign exchange market example, an increase in interest rates makes holding U.S. dollars more attractive, leading to a demand shift (D0 to D1). This also causes the supply of dollars to shift (S0 to S1), resulting in a new, stronger exchange rate equilibrium (E1) without changing the equilibrium quantity traded. This illustrates market efficiency in reacting to changing economic conditions to reach a new equilibrium.
On the supply side, producers typically find expanding production easier over several years compared to the short run. This is because building new infrastructure and expanding the workforce take time, leading to a long-term supply expansion that supports market equilibrium over longer periods.