OVERVIEW OF

GENERAL
EQUILIBRIUM THEORY

POOJA BANSAL(SEC-E 844) &

HARSHITA SHARMA (SEC-C 427)
 OVERVIEW OF GENERAL EQUILIBRIUM THEORY

• Introduction to General Equilibrium

• Basic Concepts and Assumptions
• The Exchange Economy
• Efficiency in Resource Allocation
• Production and General Equilibrium
• Market Clearing and Competitive Equilibrium
• Welfare Theorems
• Existence and Uniqueness of Equilibrium
• General Equilibrium with Production and Exchange
• Comparative Statics in General Equilibrium ,Limitations and Extensions of General Equilibrium
Theory
• Conclusion
INTRODUCTION TO GENERAL EQUILIBRIUM

• Understanding General Equilibrium: General equilibrium considers the

simultaneous interactions among all markets, addressing resource
allocation comprehensively.
• Partial vs. General Equilibrium: Partial equilibrium examines individual
markets independently, neglecting broader market interactions and
systemic implications.
• Significance in Economic Analysis: General equilibrium theory is vital
for assessing overall economic stability and efficiency in resource
distribution.
PARETO EFFICIENCY IN GENERAL
EQUILIBRIUM
• This theory explores
allocations where
resources cannot be
reallocated without
making at least one
individual worse off.
The graph shows
efficient allocations
along the contract
curve in the Edgeworth
Box.
WALRASIAN GENERAL EQUILIBRIUM

• Léon Walras’s model

demonstrates how
supply and demand
across all markets
can simultaneously
reach equilibrium. In
the graph, each
market achieves
equilibrium where
supply meets
demand.
ARROW-DEBREU MODEL

• Kenneth Arrow and

Gérard Debreu’s model
provides mathematical
proof of general
equilibrium, showing
conditions for
equilibrium existence.
The graph illustrates
intersecting markets for
production and
consumption.
COMPETITIVE EQUILIBRIUM WITH
PRODUCTION
• This model
extends
general
equilibrium by
incorporating
production,
focusing on
how firms'
production
decisions affect
equilibrium.
GENERAL EQUILIBRIUM WITH EXTERNALITIES

• Externalities cause
market failure as
they create costs or
benefits not reflected
in the market price.
The graph highlights
the social cost curve
above the private
cost curve,
representing
negative
externalities.
GENERAL EQUILIBRIUM AND PUBLIC GOODS

• Public goods are

non-excludable and
non-rivalrous,
challenging
traditional
equilibrium. The
graph shows the
social benefits curve
and the inefficiency
in public goods
provision.
DISEQUILIBRIUM THEORY

• Disequilibrium
occurs when
markets are not
in balance due to
price rigidities or
external shocks.
The graph
illustrates
scenarios with
excess demand
or supply.
TEMPORARY EQUILIBRIUM

• This theory
explores short-run
scenarios where
some markets clear
temporarily, while
others do not. The
graph shows
equilibrium in one
market with excess
in another due to
time lags.
KEYNESIAN GENERAL EQUILIBRIUM (IS-LM
MODEL)
• The IS-LM model
illustrates how
equilibrium is
achieved in the
goods and money
markets under
Keynesian theory.
It highlights
disequilibrium
due to sticky
prices and
wages.
OVERLAPPING GENERATIONS MODEL

• The OLG model

considers
intergenerational
choices in
equilibrium, such
as savings and
consumption. This
model provides
insights into long-
term equilibrium
in markets.
BASIC CONCEPTS AND ASSUMPTIONS

• Rational Behavior Assumption: Assumes consumers and producers act

logically to maximize utility or profit under available constraints.
• Market Interactions: Analyzes how changes in one market impact supply
and demand across interconnected markets simultaneously.
• Graphical Representation: Initial market equilibrium illustrated, showing
intersection of supply and demand curves indicating balanced state.
THE EXCHANGE ECONOMY

• Edgeworth Box Framework: The Edgeworth box illustrates resource

allocation in exchange economies by representing two consumers'
preferences graphically.
• Indifference Curves and Utility: Utility maximization is achieved when
indifference curves are tangential to the budget constraint, showing optimal
consumption.
• Trade Opportunities Visualization: Graphing initial endowments and
possible trades facilitates understanding of how resources are reallocated
efficiently.
 EFFICIENCY IN RESOURCE ALLOCATION

• Defining Pareto Efficiency: Pareto

efficiency occurs when no individual can
be made better off without making
someone else worse off.
• Conditions for Consumption
Efficiency: Requires allocation where
marginal rates of substitution equalize
across consumers, maximizing overall
utility in society.
• Production Efficiency Conditions:
Achieved when marginal rates of
transformation equalize, applying optimal
resource usage for both input and output.
 PRODUCTION AND GENERAL EQUILIBRIUM

• Production Possibilities Frontier

(PPF): The PPF illustrates maximum
production capabilities, showcasing
trade-offs in resource allocation between
different goods.
• Significance of the PPF: PPF analysis
aids in assessing economic efficiency,
indicating productive resources' optimal
allocation under constraints.
• Marginal Rate of Transformation
(MRT): MRT quantifies the rate at which
one good must be forgone to produce an
additional unit of another.
MARKET CLEARING AND COMPETITIVE
EQUILIBRIUM

• Competitive Equilibrium Conditions: Necessary conditions include price

equalization across markets, ensuring that supply meets demand effectively
overall.
• Walras' Law Principle: Walras' law states that if all but one market is in
equilibrium, the last must also be in equilibrium.
• Market Clearing Dynamics: Market clearing occurs when all goods and
services are sold at equilibrium prices in various interconnected markets.
 WELFARE THEOREMS

• First Welfare Theorem: Under perfect

competition, market allocations achieve
Pareto efficiency without requiring
government intervention in economy.
• Second Welfare Theorem: States that
any efficient allocation can be reached
through appropriate redistribution of initial
endowments among agents.
• Graphical Illustration: A two-good
model graphically depicts the first welfare
theorem, showing efficient allocation
along the contract curve.
 EXISTENCE AND UNIQUENESS OF EQUILIBRIUM

• Existence Conditions: Equilibrium

exists under complete markets, perfect
information, and individual rationality
ensuring coordinated resource allocation.
• Uniqueness Challenges: Establishing
uniqueness in equilibrium solutions is
hampered by multiple equilibria arising
from non-convex preferences.
• Stability Issues: Stability of equilibria
may be compromised by external shocks
or shifts in consumer and producer
behavior.
GENERAL EQUILIBRIUM WITH PRODUCTION AND
EXCHANGE

• Production's Impact on Market Outcomes: Production decisions directly

influence supply dynamics, thereby affecting prices and resource
distribution across markets.
• Combined Equilibrium Analysis: Graphically representing equilibrium
combines production and exchange reveals interdependencies between
different economic agents' behaviors.
• Feedback Loop between Production and Exchange: Changes in
production techniques alter market prices, influencing consumer choices
and subsequently impacting further production decisions.
COMPARATIVE STATICS IN GENERAL EQUILIBRIUM

• Consumer Endowments Shift: Variations in consumer endowments

directly influence equilibrium, prompting adjustments in market demand
and supply dynamics.
• Preference Changes Effects: Changes in consumer preferences lead to
shifts in demand curves, altering equilibrium prices and quantities across
markets.
• Technological Advancements Impact: Technological improvements
increase production efficiency, shifting supply curves and affecting overall
market equilibrium outcomes.
CASE STUDY: TAX REFORM AND GENERAL
EQUILIBRIUM
• This case study examines the impact of a tax reform on luxury goods.
The reform affects consumer behavior, shifting demand and impacting
equilibrium across related markets.

• As demand shifts in the luxury goods market, secondary effects spread

across the economy, demonstrating how interconnected markets
achieve new equilibrium states after policy changes.
LIMITATIONS AND EXTENSIONS OF GENERAL
EQUILIBRIUM THEORY

• Unrealistic Model Assumptions: General equilibrium models often

assume perfect competition and complete information, which rarely holds in
practice.
• Incorporating Externalities: Revising general equilibrium models to
include externalities enhances their relevance for real-world economic
scenarios.
• Public Goods Approach: Extensions addressing public goods reveal
challenges in achieving efficient allocation without market-driven solutions.
CONCLUSION

• Significance in Economic Policy: General equilibrium theory informs

policymakers on optimal resource allocation for achieving desired economic
outcomes.
• Implications for Welfare Analysis: Understanding welfare effects
enables nuanced assessments of policy impacts on various consumer and
producer groups.
• Dynamic Feedback Mechanisms: Equilibrium analysis highlights how
changes propagate across markets, influencing long-term economic stability
and growth.