General Equilibrium

Definition

General equilibrium is a state of the economy where the supply and demand for all goods, services, and factors of production are in balance, resulting in an efficient allocation of resources. It represents a comprehensive, system-wide analysis of the interdependence of markets and the interactions between various economic agents.

5 Must Know Facts For Your Next Test

1. General equilibrium analysis considers the interdependence of all markets in an economy, unlike partial equilibrium analysis which focuses on a single market.
2. The concept of general equilibrium was developed by the French economist Léon Walras in the late 19th century, laying the foundation for modern neoclassical economic theory.
3. In a general equilibrium, the prices of all goods and services are determined simultaneously through the interaction of supply and demand across all markets.
4. Achieving general equilibrium requires that the quantity supplied and the quantity demanded are equal in all markets, resulting in an efficient allocation of resources.
5. General equilibrium analysis is used to study the impact of changes in one market on the entire economic system, as opposed to the isolated effects observed in partial equilibrium analysis.

Review Questions

• Explain the key differences between general equilibrium and partial equilibrium analysis.
  • The primary distinction between general equilibrium and partial equilibrium analysis is the scope of the examination. Partial equilibrium focuses on a single market or a small subset of markets, holding all other factors constant, to determine the equilibrium price and quantity. In contrast, general equilibrium analysis considers the interdependence of all markets in an economy, recognizing that changes in one market can have ripple effects across the entire economic system. General equilibrium provides a more comprehensive understanding of how the economy functions as a whole, whereas partial equilibrium offers a more narrowly focused perspective on specific markets.
• Describe the concept of Walrasian equilibrium and its role in the general equilibrium framework.
  • Walrasian equilibrium is a specific type of general equilibrium where the prices of all goods and services are determined by the simultaneous interaction of supply and demand in all markets. This equilibrium, developed by the French economist Léon Walras, represents a state where the quantity supplied and the quantity demanded are equal in all markets, resulting in an efficient allocation of resources. The Walrasian equilibrium is a foundational concept in neoclassical economic theory, as it demonstrates the ability of a market-based economy to achieve a state of optimal resource allocation through the price mechanism, provided certain assumptions are met.
• Analyze the relationship between general equilibrium and the concept of Pareto efficiency, and explain how they are connected.
  • General equilibrium and Pareto efficiency are closely linked concepts in economic theory. Pareto efficiency is a state of resource allocation where it is impossible to make one person better off without making at least one other person worse off. In a general equilibrium, the simultaneous clearing of all markets leads to a Pareto efficient outcome, as the interaction of supply and demand ensures the optimal allocation of resources. This is because in a general equilibrium, any reallocation of resources away from the equilibrium point would make at least one individual worse off. Therefore, the Walrasian general equilibrium, which represents the intersection of supply and demand in all markets, corresponds to a Pareto efficient outcome, demonstrating the connection between these two fundamental concepts in neoclassical economic analysis.

Related terms

Partial Equilibrium: Partial equilibrium analysis focuses on a single market or a small subset of markets, holding all other factors constant, to determine the equilibrium price and quantity.

Walrasian Equilibrium: Walrasian equilibrium is a type of general equilibrium where the prices of all goods and services are determined by the interaction of supply and demand in all markets simultaneously.

Pareto Efficiency: Pareto efficiency is a state of resource allocation where it is impossible to make one person better off without making at least one other person worse off, representing an optimal outcome in a general equilibrium framework.