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From micro to macro: How does aggregate equilibrium theory change our understanding of markets?
In economics, general equilibrium theory aims to explain the interaction of supply, demand, and prices among markets throughout an economy. The core of this theory is that the interaction of demand and supply will eventually lead to an overall equilibrium state. In contrast, partial equilibrium theory focuses on a specific part of the economy, assuming that other factors remain constant.
General equilibrium theory not only studies economies modeled with equilibrium prices, but also attempts to determine the conditions under which the theory's assumptions hold.
The theory's roots can be traced back to the 1870s, particularly to the foundations laid by French economist Leon Walras in his seminal 1874 work, The Elements of Pure Economics. In the 1950s, Kenneth Arrow and Gerard Debreu, among others, further refined the theory into its modern form.
Overview of General Equilibrium Theory
General equilibrium attempts to understand the economy as a whole from the "bottom up," starting with individual markets and economic agents. Therefore, general equilibrium theory is traditionally considered as a part of microeconomics. However, with the emphasis on microfoundations in modern macroeconomics, the distinction between the two is no longer so clear.
The prices and production of all commodities in the market system are interrelated, and changes in the price of any one commodity may indirectly affect the prices of other commodities.
In a market system, if the price of a commodity changes, this will affect the demand for the corresponding labor force, thereby changing the supply and price of the commodity. This shows that the calculation of the equilibrium price of a single commodity actually needs to take into account the interactive effects of countless commodities.
Walrasian equilibriumThe first attempt to model prices for an entire economy was made in Walras's Elements of Pure Economics. In this series of models, Walras gradually took into account more real economic factors. Although some scholars have criticized Walras's model for its inconsistencies, his influence on later economics cannot be underestimated.
Walras's procedure, which proposed that equilibrium might not always be unique or stable, greatly inspired 20th-century economists.
Walras pointed out that when demand exceeds supply, prices should rise; and in the case of excess supply, prices should fall. Although Walras could not give a clear termination condition for this process, his exploration laid an important foundation for the study of economic equilibrium.
Modern General Equilibrium Theory
The concept of modern general equilibrium was mainly established by Arrow, Debreu and Mackenzie in the 1950s. The models they propose are no longer limited to specific markets, but are able to cover the complex interactions of more economic activities.
In different markets, the location, time and condition of goods delivery can affect the state of overall equilibrium, providing us with a more comprehensive perspective for economic analysis.
The value of this model is that it not only supports theoretical research, but also provides simplified guidance for actual economic operations, although it is still far from the operating model of the real economy.
Characteristics and properties of overall equilibrium
In overall equilibrium analysis, the primary issue is to study the conditions for the existence of equilibrium and its efficiency. If the market equilibrium is Pareto efficient, then the allocation of resources cannot be altered to benefit one consumer without harming other consumers. However, in the presence of externalities and market imperfections, the risk of market failure increases.
Of course, there are cases where non-unique equilibria exist, further complicating our economic understanding.
The second welfare theorem states that every Pareto efficient allocation of resources can be supported by some set of prices. This suggests that efficiency issues and fairness issues can be considered separately and there will not be a direct trade-off between the two.
Future thinking direction
With the development of economics and the introduction of new technologies, researchers have begun to pay attention to the impact of incomplete markets in the study of overall equilibrium. For example, underdeveloped financial institutions or credit constraints faced by certain groups of people may lead to a loss of market efficiency. Therefore, thinking about overall equilibrium needs to take into account a more complex economic environment.
In this case, the actual operation characteristics and structure of the market and its impact on the behavior of participants will become an important direction for future research. Faced with the ever-changing economic landscape, whether the general equilibrium theory can adapt to and explain the current reality is obviously a question worth pondering?
