General equilibrium is a core concept in economics focused on understanding how all markets in an economy interact and reach a state of balance simultaneously.
Understanding General Equilibrium
General equilibrium analysis, according to the reference, is the branch of economics concerned with the simultaneous determination of prices and quantities in multiple inter-connected markets.
Unlike models that look at markets in isolation, general equilibrium considers how changes in one market can ripple through and affect others. For example, a change in the price of oil doesn't just affect the fuel market; it also impacts transportation costs, which then affects the price of goods transported, potentially influencing consumer demand and production decisions across various industries.
General vs. Partial Equilibrium
The reference highlights the key distinction between general equilibrium analysis and partial equilibrium analysis – models that consider only a single sector.
| Feature | General Equilibrium Analysis | Partial Equilibrium Analysis |
|---|---|---|
| Scope | Multiple inter-connected markets | Single market/sector |
| Focus | Simultaneous determination of prices and quantities across economy | Determination of price and quantity in one market |
| Interactions | Explicitly models interactions and feedback effects across markets | Assumes other markets are unaffected |
General equilibrium analysis provides a holistic view of the economy, attempting to model complex relationships between supply, demand, production, consumption, and prices across all sectors.
Key Aspects of General Equilibrium
- Interconnectedness: Recognizes that markets are not isolated; changes in one market spill over into others.
- Simultaneity: Aims to find prices and quantities where supply equals demand in all markets at the same time.
- Efficiency: Often used to analyze the conditions under which a general equilibrium is Pareto efficient – a state where no one can be made better off without making someone else worse off.
- Complexity: Building comprehensive general equilibrium models is complex due to the vast number of variables and interactions involved. Economists often use simplified models or computational techniques (like CGE models) to analyze specific policy impacts.
Understanding general equilibrium is crucial for analyzing economy-wide phenomena, such as the effects of major tax reforms, technological changes, or global trade shifts. It provides a framework for thinking about how an entire economic system reaches a state of balance where resources are allocated and prices are determined across all interdependent sectors.
