Chapter 11 Walras and General Equilibrium GE Theory

Chapter 11: Walras and General Equilibrium (GE) Theory Questions for Review, Discussion and Research 1, 2, 3, 6, 10

n n GE approaches consider the interaction between households and producers Early precursors include I) Quesnay’s Tableau II) Cournot’s use of calculus in a) Profit maximizing behaviour of firms b) Interdependent nature of all sectors in a market economy

n n Walras was the first to give the GE approach vision, clarity and precision through the use of mathematical formulations Showed that the interdependent relationships between households and producers can trace all the direct, indirect and cross market effects when there is an exogenous change in a variable Overhead pp. 308 -309

n 1. 2. 3. 4. 5. One can construct a circular flow diagram on the private sector when one assumes Household preferences remain constant Level of technology is fixed Full industry integration (no intermediate products) All input and output markets are perfectly competitive Full employment

n n It is misleading to think of one variable determining the value of another as all are determined simultaneously Walras’ genius lay in his system of simultaneous equations that trace the interrelatedness of all sectors Overhead pp. 313 -314

Problems with Walrasian GE Theory 1. Debreu and Arrow only proved the existence of a GE solution in the 1950’s and the possibility of multiple equilibria is a serious limitation 2. Connections to real world is tenuous and GE Theory has been called the celestial mechanics of a nonexistent world

Problems with Walrasian GE Theory Cont’d 3. Primarily and exchange model using the concept of “tatonnement” where an auctioneer: a. Processes all bids and offers b. Determines which prices that clear all markets c. Then allows trades 4. No attempt to measure the concepts empirically

Pareto n n n Disciple of Walras Father of the branch of welfare economics that uses a general equilibrium framework Pareto Optimal outcomes occur when an ideal distribution of scarce resource inputs exists and it is impossible to make someone better off without making someone worse off

A. C. Pigou n n Marshall’s successor at Cambridge Father of the Partial equilibrium branch of welfare economics that refined Marshallian insights into market failures and externalities