General Equilibrium Theory
Candlefocus EditorRather than analyzing only single markets, as with partial equilibrium analysis, general equilibrium looks at the entirety of an economy. This involves analysis of all markets at the same time, including input markets (for labor and materials) as well as output markets (for goods and services). Components of the model may include money and banking, government, international trade and investment, and so on.
The theory states that when the supply and demand of multiple markets are in equilibrium, a state called a Walrasian equilibrium is reached. This is defined as a situation in which all markets clear, which means the quantity supplied in a market is equal to the quantity demanded. In other words, there is an ideal balance between participating buyers and sellers. This balance is known as a price equilibrium, in which prices are equilibrated according to both supply and demand. Without this balance, an economy would be dysfunctional and unable to allocate resources efficiently.
To achieve this balance, the price of a good or service must adjust to reflect the changes in the levels of supply and demand. This is due to market feedback, where the prices and quantities adjust until they reach equilibrium. Often, price equilibrium is attained through marginal adjustments, meaning the price of a particular good or service is continually adjusted based on the changes in the amount of supply or demand.
Overall, General Equilibrium Theory is an essential component of economic analysis, as it offers an approach for understanding how an economy works as a whole. It gives an understanding of how supply and demand interact within an economy and the feedback mechanisms that create the ideal balance of prices, leading to efficiency and optimal production outcomes.