General equilibrium theory

Submitted To:
Dr. M. G. Dhandliya
Associate Research Scientist
Dept. of Agriculture Economics
JAU, Junagadh
Submitted By;
Keval kakadiya
M.Sc.(Agri.) Econ.

Definition :
 A general equilibrium is define as state in which all market all
decision making unit are in simultaneous equilibrium.
 fundamental feature of any economy system is interdependence
among its constituent part.
 The markets of all commodities and all productive factors are
interrelated and price in all market are simultaneously
determined.
3

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The economy activity in the take the forms o two flows between the
consumer sector and the business sector :
a real flow and a monetary flow.
 Real flow……….
It is the exchange of goods for service of factor of production;
firms produces and after final goods to the households sector and
consumer after to firms the services of factor which they own.
 Monetary flow………
it is the real flow expressed in monetory firms. The expenditure
of firms because the money income of household similarly, the
expenditures of household become the the receipt of firms.

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• The real flow and monitary flow, which represent the transaction and
the interdependence of two sector move in opposite direction.
• They are linked by the price of goods and services economic system is
in equilibrium when a set of price attained at which magnitude on the
income flow from firms to households is equal to the magnitude of
money expenditure flow from households to firms.
Conti…

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Circular flow of income in two sector economy

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A general equilibrium is exists in each market is reach
at a positive price.
Each consumer maximizing satisfaction and each firm
maximizing profit.
The scope of general equilibrium analysis is the
examination of how this state can be achieved And
prices are determined in all market.
So that there is neither excess demand nor excess
supply.
While at the same time the individual economic units
attain their own goals

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The Walrasian system
The most ambitious general equilibrium model was developed
by the French economist Leon Walras (1834-1910).
In the Walrasian Model the behaviour of each individual
maker is presented by set of equation:
For Example:
Each consumer has a double role he buys commodities and
sells services of factors to firms.
Means each consumer have a set of equation of two subsets.

 One describing his demand for various commodities
and other his supplies services to firms.
 Similarly the behaviour of each firm equation has
two subsets one is quantities of commodities that it
produced and other is demand for factor
inputs(services) for each commodity produced.
 Important feature of this equations is simultaneously
or interdependence.
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Conti…

Assume that-
An economy consists of two consumers , A and B – who
own two factors of production K and L.
These factors are used by two firms to produce two
commodities , X and Y.
This is simple 2*2*2 general equilibrium model.
Which is explain as follows:
It is assumed that each consumer produces one commodity
and each buys same quantity of both.
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In this simple model we have the following unknown:
1. Quantities demanded of X and Y by consumer 2*2 = 4a
2. Quantities supplied of K and L by consumer 2*2 = 4
3. Quantities demanded of K and L by firms 2*2 = 4
4. Quantities of X and Y supplied by firms 2 = 2
5. Prices of commodities X and Y 2 = 2
6. Prices of factors K and L 2 = 2
7. Total number of “unknown” =18

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To find these unknowns we have the following number of
equations:
1. Demand functions of consumers 2*2 = 4
2. Supply function of factors 2*2 = 4
3. Demand function for factors 2*2 = 4
4. Supply function for commodities 2 = 2
5. Marketing of commodities 2 = 2
6. Market of factors 2 = 2
7. Total number of equations = 18

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Since the number of equations is equal to number of
unknowns, one should think that a general equilibrium
solution exits.
No. of Equation = No. of Unknown
This is the Walrasian Model for General Equilibrium.
Conti....

1. GET is the most complete existing model economic behavior. GET
byviewing the economy as a vast system of mutualy interdependent
market, make the once aware of the tremendous complexity of real
world.
2. Under certain assumption the GET has a solution. It yield a set of price
ratios which lead to an optimal allocation of resources.
3. It used as a norm to judge the significance and implications of
derivatives of the various markets from the ‘ideal’ state of equilibrium.
4. GET can be helpful in the resolution of macro- economics
controversies.
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Concluding remarks / usefulness

General equilibrium theory

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General equilibrium theory