General equilibrium theory

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The theory of general equilibrium is a model of the branch of microeconomics that studies the interaction and equilibrium point between the different markets of an economy. It is also known as the Walrasian general equilibrium theory, after its developer.

General equilibrium is an economic model that seeks to explain the behavior, interaction and equilibrium between the different markets of the economy. Its study includes consumption, production, price formation, the determination of wages and the way in which an equilibrium is reached that determines the final distribution of resources.

Thus, for example, when observing the bread market, the general equilibrium model also studies how this market interacts with other related ones (for example, butter as complementary good, wages of bread producers, cookies as substitute goods, etc.)

General equilibrium differs from partial equilibrium in that the latter only focuses on analyzing a particular market (for example, the bread market) considering that the prices of other goods and services remain constant. In general equilibrium all prices are variable and all markets are required to adjust.

Nor should we confuse general equilibrium with macroeconomics, the latter studies economic aggregates at the national or regional level, analyzing global indicators such as the level of employment, inflation, investment, etc. This is different from analyzing the interaction between different markets that make up an economy at the macro level.

Market equilibrium Macroeconomic equilibrium

Origin of general equilibrium

One of the first general equilibrium models was developed at the end of the 19th century by the French mathematician and economist León Walras. In his work "Elements of Pure Economics", Walras proposes a model with n markets where prices are adjusted so that the sum of excess demand becomes zero. Among the most important assumptions of your model are:

  • There is perfect competition. Agents are price takers, there is no intervention in the price system and no hoarding of goods.
  • The figure of the "Walras auctioneer" is created who announces prices and is an intermediary or auctioneer between buyers and sellers. No transactions are made when the prices offered by buyers and sellers are unbalanced. The auctioneer will sing the prices again until they adjust to equilibrium.

Later, other economists and mathematicians such as Vilfredo Pareto, Kenneth Arrow, Gerard Debreu and Lionel W. McKenzie included improvements to the Walras model. And they also developed alternative general equilibrium models.

Why study general equilibrium

General equilibrium analysis is an indispensable tool to be able to answer certain basic questions of economics that partial analysis could not answer.

Thus, for example, when we want to determine if the economy works efficiently, it is not enough to observe a single market, we must observe the economy as a whole and how the adjustments in one market affect other related markets directly or indirectly.

Likewise, when we want to study the factors that determine economic development we must apply a general equilibrium since there are interrelationships between different markets that determine the final effect of the adjustment of a certain variable (thus, for example, if the wages of a sector of the economy increase , this increase generates a positive effect on other sectors by increasing their sales).

Money market equilibrium

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