General Equilibrium

Definition

General equilibrium refers to a state in an economy where all markets are in balance simultaneously, and the supply and demand across all sectors are met. This concept highlights the interconnections among various markets, showing how changes in one market can affect others, and is crucial for understanding how resources are allocated efficiently in an economy.

5 Must Know Facts For Your Next Test

1. General equilibrium analysis considers the interactions between different markets and how they influence each other, unlike partial equilibrium which isolates a single market.
2. The existence of general equilibrium requires certain conditions, such as perfect competition, complete information, and rational behavior among consumers and firms.
3. General equilibrium models can help predict the effects of economic policies by analyzing how changes in one market can ripple through the economy.
4. One of the foundational contributions to general equilibrium theory was made by Léon Walras, who formulated the conditions for equilibrium in a market economy.
5. Computational general equilibrium models are often used in economic research to simulate the impact of policy changes across various sectors of the economy.

Review Questions

• How does general equilibrium differ from partial equilibrium in analyzing economic outcomes?
  • General equilibrium takes into account the interactions between multiple markets and how they affect each other, while partial equilibrium focuses solely on one market without considering these broader implications. This means that general equilibrium can provide a more comprehensive understanding of resource allocation and welfare effects across the entire economy. In contrast, partial equilibrium may overlook important externalities and interdependencies that could influence market outcomes.
• What role does Walras' Law play in establishing conditions for general equilibrium?
  • Walras' Law is essential for understanding general equilibrium because it states that if all but one market are in equilibrium, then the remaining market must also achieve equilibrium. This principle underlines the interconnectedness of markets and reinforces the idea that a disturbance in one market will influence others. By relying on this law, economists can analyze complex economies where multiple goods and services interact simultaneously, providing insights into how policies or shocks might affect overall economic stability.
• Evaluate the significance of general equilibrium analysis in modern economic policy-making and its implications for efficiency and welfare.
  • General equilibrium analysis holds significant importance in modern economic policy-making as it offers a holistic view of how different markets interact and respond to changes. By understanding these dynamics, policymakers can better anticipate the effects of their decisions on various sectors and overall economic welfare. The implications for efficiency are profound; general equilibrium helps identify optimal resource allocation and potential areas for intervention. Additionally, it highlights the trade-offs involved when altering policies, ensuring that the benefits and costs are considered comprehensively across the economy.

Related terms

Partial Equilibrium: A condition where supply and demand in a single market are balanced, without considering the impact on other markets.

Pareto Efficiency: A state where resources are allocated in a way that no individual can be made better off without making someone else worse off.

Walras' Law: The principle stating that if all but one market in an economy are in equilibrium, then the remaining market must also be in equilibrium.