What Is General Equilibrium Theory?

General equilibrium theory, or Walrasian general equilibrium, attempts to explain the functioning of the macroeconomy as a whole, 🧔rather than as collections of individual market phenomena.

The theory was first developed by the French economist Leon Walras in the late 19th century. It stands in contrast with partial equilibrium theory, or Marshallian partial equilibrium, which only analyzes specific markets or sectors.

Understanding General Equilibrium Theory

Walras 澳洲幸运5开奖号码历史查询:developed the general equilibrium theo🧸ry to solve a much-debated problem in economics. Up to that point, most economic analyses only demonstrated partial equilibrium—that is, the price at which supply equals demand and markets clear—in individual markets. It wasꦡ not yet shown that equilibrium could exist for all markets at the same time in aggregate.

General equilibrium theory tried to show how and why all free markets tend toward equilibrium in the long run. The important fact was that markets didn't necessarily reach 澳洲幸运5开奖号码历史查询:equilibrium, only that they tended toward it.

Around 1900, Walras wrote, “The market is like a lake agitated by the wind, where the water is incessantly seeking its level without ever reaching it.”

General equilibrium theory builds on the coordinating processes of a free market price system, first widely popularized by Adam Smith's "The Wealth of Nations" (1776). This system says traders, in a bidding process with other traders, create transactions by buying and selling goods.

Those transaction prices act as signals to other producers and consumers to realign their resources and activities along more profitable lines.

Walras, a talented mathematician, believed he proved that any individual market was necessarily in equilibrium if all other markets were alജso in equilibrium. T⛦his became known as Walras’s Law.

Special Considerations

There are many assumptions, realistic and unrealistic, inside the general equilibrium framework. Each economy has a finite number of goods in a finite number of agents. Each agent has a continuous and strictly concave 澳洲幸运5开奖号码历史查询:utility function, along with possesℱsion of a single pre-existing good (the “🌱production good”).

To increase their utility, each agent must trade their production good for ot🎃her goods to be♐ consumed.

There is a specified and limited set of market prices for the goods in this theoretical economy. Each agent relies on these prices to maximize their utility, thereby creating supply and demand for various goods. Like 🧸most equilibrium models, markets lack uncertainty, imperfect knowledge, or innovation.

Alternatives to General Equilibrium Theory

Austrian economist Ludwig von 💛Mises developed an alternative to lonജg-run general equilibrium with his so-called Evenly Rotating Economy (ERE).

This was another imaginary construct and shared some simplifying assumptions with general equilibrium economics: no uncertainty, no monetary institutions, and no disrupting changes in resources or technology. The ERE illustrates the necessity of entrepreneurship by showing a system where none existed.

Another Austrian economist, Ludwig Lachmann, argued the economy is an ongoing, non-stable process replete with subjective knowledge and subjective expectations. He argued that equilibrium could never be mathematically proven in a general or non-partial market.

Those in💯fluenced by Lachmann imagine the economy as an open-ended evolutiona𝓰ry process of spontaneous order.

The Bottom Line

Leon Walras developed the general equilibrium theory which shows how all markets in an economy interact with one another and tend toward a balance. Though the theory has been influential, it relies on certain assumptions that have been challenged by detractors. These assumptions include perfect know𓆉ledge and no uncertainty in an economy, which are not realistic factors in actual economies.