General Equilibrium
What is General Equilibrium?
General equilibrium is a state in which every market in the economy clears at once, with all prices adjusted so supply equals demand everywhere.
General equilibrium analysis treats the economy as one connected system: prices in every market adjust together until quantity supplied equals quantity demanded in all of them simultaneously. It takes seriously that markets feed back on each other, so a shock to the oil market changes wages, the demand for cars, and the price of plastics, which then feed back into oil. The payoff is consistency, because the answer accounts for every knock-on effect instead of stopping at the first market. The cost is complexity, since solving a general equilibrium model needs assumptions about every market and every consumer. Partial equilibrium is the simpler alternative that studies one market with everything else held constant, which is usually accurate enough when the market is small relative to the economy.
General Equilibrium: a worked example
Suppose a drought cuts the corn harvest. Partial equilibrium stops after one step: less supply, so the price of corn rises and the quantity falls. General equilibrium follows the chain further. Dearer corn raises the cost of feeding cattle, so beef supply falls and beef prices rise; households facing higher food bills cut spending on restaurant meals, which lowers demand for restaurant labor and softens those wages; ethanol refiners bid less for corn, easing part of the original price rise. General equilibrium finds the set of prices at which corn, beef, restaurant meals, and labor all balance at the same time.
The mistake students make with general equilibrium
Students often assume general equilibrium means the economy is at full employment or that everything is efficient. It means only that all markets clear at the prevailing prices; whether the outcome is fair or even desirable is a separate question. Another mix-up is treating general equilibrium as a macro topic. It is a microeconomic framework about many interacting markets, and macro models borrow from it rather than own it.
General Equilibrium questions
What is the difference between general equilibrium and partial equilibrium?
General equilibrium solves for prices in all markets at once, while partial equilibrium solves one market with all other prices held fixed. Partial equilibrium is faster and is usually fine for a small market, but it misses feedback from related markets. General equilibrium captures that feedback at the cost of far more structure and assumptions.
Why does general equilibrium matter for policy?
General equilibrium matters because a policy aimed at one market almost always changes others. A tax on gasoline changes driving, but it also changes demand for cars, housing near transit, and refinery labor, and those responses can shrink or magnify the intended effect. Ignoring them can make a policy look far cheaper or far more effective than it really is.
How do economists actually solve a general equilibrium model?
Economists write supply and demand for every good and factor, then find the set of prices that drives excess demand to zero in all of them at once. Because only relative prices matter, one good is fixed as the unit of account and every other price is measured against it. Modern versions are solved numerically on a computer, calibrated to data on production and spending.
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Related terms
Common comparisons
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