General Equilibrium Analysis | UGC NET Economics – Notes

Introduction

• Economic analysis seeks to explain how individuals, firms, and markets allocate scarce resources to satisfy unlimited wants. Economists analyze economic problems either by studying a single market in isolation or by examining the interactions among all markets in the economy. Based on the scope of analysis, economic equilibrium is classified into Partial Economic Analysis and General Economic Analysis. While partial analysis focuses on the equilibrium of a single market assuming that other markets remain unchanged, general analysis studies the simultaneous determination of equilibrium in all interconnected markets. Both approaches are fundamental tools of microeconomic theory and are widely used for understanding market behaviour, resource allocation, price determination, and economic welfare.
• The distinction between partial and general economic analysis was developed primarily through the contributions of Alfred Marshall and Léon Walras. Marshall introduced the concept of partial equilibrium analysis to simplify economic problems by examining one market at a time. Walras, on the other hand, developed the theory of general equilibrium, demonstrating that all markets in an economy are interconnected and must be analyzed simultaneously to understand the complete functioning of an economic system.
• The type of analysis where we do not take into account the interrelationship or interdependence between prices of commodities and factors of production is called partial equilibrium analysis. Partial equilibrium analysis focuses on explaining the determination of price and quantity in a given product or factor market when one market is viewed as independent of other markets.
• However partial equilibrium is not useful and relevant to apply when there is strong relationship between commodities or between factors. Thus when markets for various commodities and factors are interdependent that is when changes in the price of a commodity or a factor has important repercussions on the demand for other commodities or factors, partial equilibrium analysis would not yield correct results.
• In such cases when there is such interrelationships between various markets or that the changes in one market would significantly affect others, we should employ general equilibrium analysis which considers simultaneous equilibrium of all markets taking into account all effects of changes in price in one market over others.

Partial Equilibrium Analysis

• This approach is the determination of the price and quantity in each market by demand and supply curves drawn on the ceterus peribus clause.
• It was introduced by Marshallian Approach.
• It studies the internal outcome of any policy action in a single market only.
• The effects are examines only in the markets which is directly affected not on other markets.
• We refer to partial equilibrium analysis when a single firm or a single firm or a single consumer is in equilibrium other firms may not be in equilibrium.
• It studies the behavior of individual decision making units and the working of individual market in isolation.
• It ignore interdependence and inter-connections among different market.
• It takes into account of Impact effect.

General Equilibrium Analysis

• General equilibrium analysis, unlike partial equilibrium analysis, is concerned with the economic system as a whole. It recognises that the economic system is a network in which all the parts are mutually dependent on one another and are in mutual interaction with one another.

• Goods are either competitive or substitutes. Some goods are used in the manufacture of other goods. Factors of production are complementary to each other, and to the extent that they can be substituted for one another, they are also competitive. Resources also face competitive demand from producers. Therefore, any change in the demand or supply of a commodity or factor of production sets in motion a chain reaction, and a disturbance in one sector of the economy produces repercussions throughout the economy.

• General equilibrium analysis is concerned with the overall effects of an economic disturbance. Instead of considering only a few variables at a time, it takes into account all the relevant variables that may affect the particular economic phenomenon under study. In this type of analysis, all the side-effects of an economic disturbance are analysed comprehensively.

• An example helps explain the concept of general equilibrium. Suppose the demand for India-manufactured consumer goods suddenly increases in Western Europe. As a result, Indian exports increase, leading to higher output, employment, and profits in the export industries. Resources are diverted from other industries to the export industries, while the demand and prices of substitute commodities also increase. Thus, the increased demand for exports produces economy-wide effects, and a complete analysis of these repercussions can only be carried out through general equilibrium theory.

• General equilibrium analysis deals with the equilibrium of the entire economic organisation, including consumers, producers, resource owners, firms, and industries. Not only should individual consumers and firms be in equilibrium individually, but they should also be in equilibrium with one another.

• Business firms enter the product markets as suppliers, while they enter the factor markets as buyers. Households, on the other hand, are buyers in the product markets but suppliers in the factor markets. General equilibrium prevails when both the product markets and the factor markets are in equilibrium with each other.