Nova workboard

a blog from young economists at Nova SBE

General Equilibrium: Let’s put it all together

General equilibrium have the objective of proving that all prices are at equilibrium, studying supply and demand fundamentals in an economy with multiple markets. Analyses the mechanism by which the choices of economic agents are coordinated across all markets. It attempts to look at several markets simultaneously rather than a single market in isolation, as partial equilibrium theory.

The general equilibrium model has traditionally been used to analyse the effects of a change in economic policy such as the imposition of a tariff or quota on imported goods, the granting of export subsidies, or a modification of the tax code. It can be used to explore the consequences of an increase in the price or reduction in the supply of an imported good such as oil, the ramifications of an unexpected fall in the supply of food, or a major change in the regulation of an industry. In each of these cases, the parameters of the model are required to yield current price and output levels as the solution of the general equilibrium model prior to the change. A recalculation is then done that predicts the consequences of the proposed change on a variety of variables: prices, levels of output, government receipts, and the distribution of income among the consuming units.

General equilibrium theory has provided economics with a very sound set of powerful tools and has instilled discipline of though and analytical rigor. The influence of general equilibrium has been pervasive even beyond its original and traditional microeconomics setting. Industrial organization has evolved from its partial equilibrium beginnings and has adopted some of the general equilibrium flavour. International trade theory is nothing but general equilibrium between countries or regions.

An actual economy, after all, is composed of numerous agents, markets and institutions, all of them interacting in the social medium and general equilibrium theory gives us insights as to what can we expect, in economic terms, from such a complex interaction.

One of the major virtues of the general equilibrium model is its ability to trace the consequences of large changes in a particular sector through-out the entire economy. It shares this property with input-output analysis but permits a more flexible treatment of the consumer side of the economy and is less rigid in the requirements placed on the productive side.

However, the model is inadequate in its treatment of money and financial institutions, it has great difficulty in allowing for unemployed resources, and it is unable to cope with large-scale industrial enterprises.  In spite of its imperfections, this method of analysis will retain its usefulness until economic theory is capable of providing compelling alternative formulations.

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Author: studentnovasbe

Master student in Nova Sbe

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