General Equilibrium is an economic concept where all markets in an economy are in a state of simultaneous equilibrium. This implies that the quantity supplied equals the quantity demanded across all markets without any excess supply or demand. Achieving general equilibrium ensures that resources are allocated efficiently across the economy, with no market experiencing a disequilibrium that could ripple through to others.
Key Characteristics
- Simultaneous Equilibrium: Achieved when all markets (goods, services, labor, capital, etc.) are in equilibrium at the same time.
- Interconnectedness: Changes in one market affect others, requiring all adjustments to consider systemic interdependencies.
- Market Clearing: No surpluses or shortages exist; every commodity’s market clears.
Theoretical Foundations
General Equilibrium theory was first rigorously formulated by Léon Walras in the 19th century. His model, often referred to as the Walrasian Model, laid the groundwork for understanding how individual markets converge to an overall economy-wide equilibrium.
Walras Law
The core principle behind general equilibrium is Walras’ Law, which states that if all but one of the markets in an economy are in equilibrium, then the last market must also be in equilibrium. This principle underpins the interconnectedness of markets.
Arrow-Debreu Model
Another significant extension of the general equilibrium concept is the Arrow-Debreu Model. Kenneth Arrow and Gérard Debreu extended Walras’ work to include issues like uncertainty and time, providing a more realistic depiction of markets.
Examples and Applications
Example in Simple Economy
Consider a simplified economy with two markets: one for apples and one for oranges. For the economy to be in general equilibrium, the quantity of apples supplied must equal the quantity demanded for apples, and the same applies to oranges. If consumers suddenly prefer more apples and fewer oranges, both markets adjust prices and quantities to restore equilibrium simultaneously.
Real-World Application
In real-world economies, achieving general equilibrium can guide policy decisions like setting interest rates or taxes. For example, central banks may look at labor and goods markets to ensure policies are fostering balanced growth without overinflation or unemployment.
Comparisons and Related Terms
Partial Equilibrium
Partial Equilibrium analysis deals with the equilibrium in a single market, ignoring interactions with other markets. While helpful for isolating specific market factors, it lacks the comprehensive insight offered by general equilibrium analysis.
Market Equilibrium
Market Equilibrium refers generally to the state where supply equals demand; it can be applied to individual markets and does not imply the interconnectedness inherent in general equilibrium.
FAQs
What is the difference between general and partial equilibrium?
How is general equilibrium achieved?
Why is general equilibrium important?
References
- Walras, Léon. “Elements of Pure Economics.”
- Arrow, Kenneth J., and Gérard Debreu. “Existence of an Equilibrium for a Competitive Economy.”
- Hirsch, Morris, and Stephen Smale. “Differential Equations, Dynamical Systems, and Linear Algebra.”
Summary
General Equilibrium represents a state where all markets in an economy are balanced, with supply equaling demand across the board. Originating from the works of Léon Walras and extended by economists like Arrow and Debreu, it serves as a cornerstone for economic theories and policies. Understanding general equilibrium helps in comprehending complex economic interdependencies and crafting effective economic strategies.
