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The Hidden Economic Secret: Why Can General Equilibrium Theory Predict Price Changes?
Among the countless theories of economics, the charm of general equilibrium theory cannot be ignored. It not only attempts to reveal changes in supply, demand and prices, but also observes the operation of the market from a holistic perspective. Why is it said that this theory can predict price changes? This is actually a question that concerns countless economists and industry professionals.
Origins of General Equilibrium Theory
The roots of general equilibrium theory can be traced back to the 1870s, when French economist Léon Walras first proposed it in his book The Elements of Pure Economics. The basic idea of this theory is that the prices of all commodities in the market influence each other, and when supply and demand interact with each other, an overall equilibrium state will eventually be reached.
General equilibrium theory attempts to understand the economy as a whole by taking individual markets and actors as a starting point. This bottom-up approach is the essence of general equilibrium theory.
From local equilibrium to general equilibrium
Compared to local equilibrium theory, general equilibrium theory focuses on the operation of the overall economy. Local equilibrium focuses only on the supply and demand of a particular good, assuming that other markets remain unchanged. Such assumptions are not entirely reliable when analyzing complex markets, especially when industries interact with each other.
For example, if the price of bread rises, how will this affect the wages of bakers? And how will this further affect consumers' purchasing intention and demand? These considerations cannot be fully presented within the framework of local equilibrium.
Walrasian equilibrium and stability
Walras's model provides a perspective on the entire economic system. Although point-to-point theories may not be completely consistent or stable, this framework has pioneered the research style of many subsequent economists. In particular, the "auctioneer" mechanism proposed by Walras provides a clear process for changing market prices, in which price changes will prompt a rebalancing between demand and supply.
The discussion of stability issues has become an indispensable part of economists' study of general equilibrium.
Modern general equilibrium models
In the mid-20th century, Kenneth Arrow, Gérard Debreu, and Lionel McKenzie jointly developed the modern general equilibrium theory. This model further deepens the understanding of market equilibrium and emphasizes how to maintain relative price stability under the interaction of multiple markets. Especially in the interaction between financial markets and commodity markets, its framework allows us to better predict dynamic changes in prices.
Two major theorems of efficiency and welfare economics
In the discussion of general equilibrium theory, two basic theorems of welfare economics play a vital role. The first fundamental theorem states that market equilibrium is theoretically Pareto efficient, meaning that the welfare of any one consumer cannot be further improved without harming others.
The market is not only a place for transactions, but also a system that promotes the efficient allocation of resources.
The second fundamental theorem focuses on the redistribution of efficiency and fairness, indicating that any Pareto efficient allocation can be achieved through an appropriate price system. This makes people re-examine the distribution issues of the market, especially in today's highly unequal society.
Conclusion: Applications and Challenges
Although general equilibrium theory has received widespread attention in academia, in practical applications, there are still challenges such as market monopoly, information asymmetry and externalities. All of these factors may disrupt the equilibrium and lead to market failure.
Against this background, exploring the effectiveness of general equilibrium theory in predicting price changes is undoubtedly an ongoing task. Faced with a rapidly changing market environment, how can current economic theories adapt to future changes?
