Equilibrium
Types of
Equilibrium
Other
Forms of Equilibrium
Uses of
General Equilibrium
Limitations
of General Equilibrium Analysis
General
Disequilibrium (Keynesian Theory)
The term equilibrium
has often to be used in economic analysis.
In fact, Modern Economics is sometimes called equilibrium analysis. Equilibrium means a state of balance. When forces acting in opposite directions are exactly equal,
the object on which they are acting is said to be in a state of equilibrium.
Basically, there are
three types of any equilibrium:
(a)
Stable Equilibrium:
There is stable equilibrium, when the object concerned, after having been
disturbed, tends to resume its original position.
Thus, in the case of a stable equilibrium, there is a tendency for the
object to revert to the old position.
(b)
Unstable Equilibrium:
On the other hand, the equilibrium is unstable when a slight disturbance evokes
further disturbance, so that the original position is never restored.
In this case, there is a tendency for the object to assume newer and
newer positions once there is departure from the original position.
(c)
Neutral Equilibrium:
It is neutral equilibrium when the disturbing forces neither bring it back to
the original position nor do they drive it further away from it.
It rests where it has been moved. Thus,
in the case of a neutral equilibrium, the object assumes once for all a new
position after the original position is disturbed.
(a)
Short-term and Long-term Equilibrium: Equilibrium
may be short-term equilibrium or long-term equilibrium as in case of short-term
and long-term value. In the
short-term equilibrium, supply is adjusted to change in demand with the existing
equipment or means of production, there being no time available to increase or
decrease the factors of production. However,
in case of long-term equilibrium, there is ample time to change even the
equipment or the factors of production themselves, and a new factory can be
erected or new machinery can be installed.
(b)
Partial Equilibrium:
Partial equilibrium analysis is the analysis of an equilibrium position for a
sector of the economy or for one or several partial groups of the economic unit
corresponding to a particular set of data.
This analysis excludes certain variables and relationship from the
totality and studies only a few selected variables at a time.
In other words, this method considers the changes in one or two variables
keeping all others constant, i.e., ceteris paribus (others remaining the
same). The ceteris paribus is
the crux of partial equilibrium analysis.
The equilibrium of a
single consumer, a single producer, a single firm and a single industry are
examples of partial equilibrium analysis. Marshall’s
theory of value is a case of partial equilibrium analysis. If the Marshallian method (i.e., partial equilibrium
analysis) is to be effective, even in its own terms, when applied to a
hypothetical and idealised market, it necessary that the market should be small
enough so that its inter-dependence with the rest of the hypothetical economy
could be neglected without much loss of accuracy.
(i)
Consumer’s Equilibrium:
With the application of partial equilibrium analysis, consumer’s equilibrium
is indicated when he is getting maximum aggregate satisfaction from a given
expenditure and in a given set of conditions relating to price and supply of the
commodity.
(ii)
Producer’s
Equilibrium: A producer is in equilibrium when
he is able to maximise his aggregate net profit in the economic conditions in
which he is working.
(iii)
Firm’s
Equilibrium: A firm is said to be in long-run
equilibrium when it has attained the optimum size when is ideal from the
viewpoint of profit and utilisation of resources at its disposal.
(iv)
Industry’s
Equilibrium: Equilibrium of an industry shows
that there is no incentive for new firms to enter it or for the existing firms
to leave it. This will happen when
the marginal firm in the industry is making only normal profit, neither more nor
less. In all these cases; those who have incentive to change it have no
opportunity and those who have the opportunity have no incentive
.
(c)
General Equilibrium Analysis:
Leon Walras (1834-1910), a Neoclassical economist, in his book ‘Elements of
Pure Economics’, created his theoretical and mathematical model of General
Equilibrium as a means of integrating both the effects of demand and supply side
forces in the whole economy. Walras’
Elements of Pure Economics provides a succession of models, each taking into
account more aspects of a real economy. General equilibrium theory is a branch of theoretical
microeconomics. The partial
equilibrium analysis studies the relationship between only selected few
variables, keeping others unchanged. Whereas
the general equilibrium analysis enables us to study the behaviour of economic
variables taking full account of the interaction between those variables and the
rest of the economy. In partial
equilibrium analysis, the determination of the price of a good is simplified by
just looking at the price of one good, and assuming that the prices of all other
goods remain constant.
General equilibrium
is different from the aggregate or macro-economic equilibrium.
General equilibrium tries to give an understanding of the whole economy
using a bottom-top approach, starting with individual markets and agents.
Whereas, the macro-economic equilibrium analysis utilises top-bottom
approach, where the analysis starts with larger aggregates.
In macro-economic equilibrium models, like Keynesian type, the entire
system is described by relatively few, appropriately defined aggregates and
functional relationships connecting aggregate variables such as total
consumption expenditure, total investment, total employment, aggregate output
and the like. In macro-economic
analysis, many important variables and relationships tend to be disappeared in
the process of aggregation.
There are two major
theorems presented by Kenneth Arrow and Gerard Debreu in the framework of
general equilibrium:
(i)
The first fundamental theorem is that every market equilibrium is Pareto
optimal under certain conditions, and
(ii)
The second fundamental theorem is that every Pareto optimum is supported
by a price system, again under certain conditions.
1.
To get an overall picture of the
economy and study the problems involving the economy as a whole or even
large segments / sectors of it.
2.
It shows that the quantities of
demanded goods / factors are equal to the quantities supplied.
Such a condition implies that there is a full employment of
resources.
3.
It also provides with an ideal datum of
economic efficiency. It
brings out the fact that long-run competitive equilibrium is a standard of
efficiency for the entire economy. Only
when the competitive economy obtains general equilibrium shall its economic
efficiency be at its peak and there shall be no further gains made by any
reallocation of resources.
4.
General equilibrium also represents the
state of optimum production of all commodities, because there can
be no over-production or under-production under such conditions.
5.
It also provides an insight into the
way the multitudes of individual decisions are integrated by the working of the
price mechanism. It, therefore, solves
the fundamental problems of a free market economy, viz., what to
produce, how to produce, how much to produce, etc.
This analysis shows that such decisions with regard to innumerable
consumers and producers are co-ordinated by the price mechanism.
6.
The general equilibrium analysis also gives
us the clue for predicting the consequences of an economic event.
7.
It also helps in the field of
public policy. The
formulation of a logically consistent public policy requires a complete
understanding of the various sector markets and aspects of individual
decision-making units, and the impact of policy on the whole economy.
1.
The Walrasian general equilibrium
system is essentially static.
It treats the coefficient of production as fixed.
It considers the supply of resources to be given and consistent. It also
takes tastes and preferences of the society as fixed.
2.
It ignores leads and lags,
for it considers everything to happen instantaneously.
It is supposed to work just in the same way as an electric circuit does.
In the real world, all economic events have links with the past and the
future.
3.
Walrasian general equilibrium analysis
is of little practical utility.
It involves astronomical volumes of calculations for estimating the
various quantities and practices. This
makes its application practically impossible.
Even the use of computers cannot be of much help because such a system
cannot aid in collecting and recording the innumerable sets of prices and
quantities that are required to formulate these equations.
The critics further argue that even if such a solution exists, the price
mechanism may not necessarily cover it.
4.
Last but not least, the general
equilibrium analysis falls to the ground as its star assumption of perfect
competition is contrary to the actual conditions prevailing in the real
world.
Neoclassical
economics thinks in terms of a market system in which supply equals demand in
every market, so that no unemployment could ever occur.
But this is an assumption. Keynes
suggests a market system in which Disequilibrium can occur in some markets,
including labour market, and in which the disequilibrium can spread contagiously
from one market to another. Keynes’
idea was that, when this spreading disequilibrium settles down, there would be a
kind of equilibrium – not supply and demand equilibrium, but often termed as ‘general
disequilibrium’.
Take an example of a
commodity, say cellular telephone sets, its equilibrium of demand and supply is
shown in the following figure:
In the above figure,
MC curve is the marginal cost curve for the commodity.
Originally, the market is in equilibrium at price P1 with
demand curve D1. Then,
for any reason, demand for that commodity decreases to D2,
Neoclassical economists tells us that the new equilibrium will be at price P3.
But, in fact, the prices do not drop quite that far, instead, prices drop
to P2. Perhaps this is because the businessmen do not know just how
far they need to cut their prices, and are cautious to avoid cutting too much.
At a price P2, the seller can sell only Qd amount
of output. By producing Qd
amount of output at price P2, the producers are not maximising their
short-run profit. We have ‘disequilibrium’ in the sense that
production is not on the marginal cost curve.
At P2, the sellers can sell Qd amount of output,
but they cannot produce the same amount of output.
Here is a qualification. Producer
might temporarily produce more that Qd, in order to build up their
inventories. But there is a limit
to how much inventories they want, so they will cut their production back to Qd
eventually.
With a reduction of
demand for cellular phones, any economist would expect a reduction in the
quantity of that commodity produced. Neoclassical
economics leads us to expect that the price would drop to P3 and
output cut back to Qe. At
the same time, a certain number of workers would be laid off and would switch
their efforts into their second best alternatives, working in other industries,
perhaps at somewhat lower wages. But
the ‘disequilibrium model’ states that the production and layoffs would go
even further, with output dropping to Qd. A reduction in income does not only reduce the demand for
cellular phones, but it also reduces the demand for all other normal goods as
well. This disequilibrium will
spread contagiously through many different goods markets, through the effect of
disequilibrium on income. So every
other industry will face a reduction in demand because of the reductions in
productions in many other industrie
