General equilibrium analysis:
Introduction
Lectures in Microeconomic Theory
Fall 2010, Part 10
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G.B. Asheim, ECON4230-35, #10
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Purpose of equilibrium analysis

Show under which conditions the self-interested
actions
ti
off consumers andd firms
fi
lead
l d to
t a goodd
outcome for the economy as a whole.
Existence.
Pareto efficient allocation (welfare theorems).

Thereby
Th
b iindicating
di i what
h ki
kind
d off iintervention
i
should be undertaken if these conditions are not
satisfied.
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1
A competitive market is characterized by

Sellers and buyers take the market price as given and
determine their supply and demand accordingly.

The market price is determined so that
market supply = market demand.

A good is transferred if and only if the price is paid.

Sellers and buyers have the same information about
the transferred good.
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G.B. Asheim, ECON4230-35, #10
Partial vs. general equilibrium analysis

In a partial equilibrium model, all prices other than
the price of the good studied are assumed to remain
Price
fixed.
Aggregate supply for
given factor prices.
Equilibrium
price.
Aggregate demand for
given prices of other
goods and given income.
Equilibrium quantity.

Quantityy
Q
In a general equilibrium model, all prices are
variable. A general equilibrium requires that all
markets clear.
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2
Pure exchange

All economic agents are consumers.
ConsumpConsump
tion goods
Consumer 1
Consumer 2
Payments
Given the market prices and initial endowment of
consumption
n mpti n goods,
d consumers
n m r choose
h
th
the b
bestt
vector of consumption goods, given that positive
net demand of some goods must be financed by
positive net supply of other goods.
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G.B. Asheim, ECON4230-35, #10
With production

Some economic agents are consumers, other agents
are firms.
Consumption goods
and payments
Consumers
Profits
Firms
Labor (and capital) and
Given the market
Given the market
prices, each consumer wages (and interest)
prices and the
chooses a best combination of
technological constraints
constraints,
each firm chooses a
labor supply and consumption
combination of consumption
good demand, given that he
good supply and factor demand
must pay for the consumption
that maximizes profits.
goods with his labor income.
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