Chapter 8

General Competitive Equilibrium (GCE)

8.1.1 Introduction

We’ve seen product markets, factor markets, how each work and how they are part of the web of

connections

8.1.1 Introduction

Now we look at the system as a whole. Analysis at this level is called

general equilibrium theory

8.1.2 GCE Concepts

All markets are part of a simultaneous system

All elements function as a part of a larger whole,

like an ecosystem

8.1.2 GCE Concepts

Product markets are connected to one another

Through cross-price elasticities Ex. Substitutes and complements

8.1.2 GCE Concepts

Factor markets are connected to one another

Through elasticity of input substitution

8.1.2 GCE Concepts

Product and factor markets are connected to one another

Through the product supply line – cost structures from production as determined by factor markets will affect the product supply

Through the product demand line – money to demand goods and services comes from selling their resources in factor markets

Through the factor demand line – a demand derived from product demand

8.1.3 GCE versus Partial Equilibrium Analysis

The only givens are: Distribution of shares of social

endowment Individuals’ tastes Current technology

8.1.3 GCE versus Partial Equilibrium Analysis

In theory because of the interconnections as long as any market is adjusting, all markets are adjusting

8.1.3 Partial Equilibrium Analysis

That perspective is so wide-reaching, it is too hard to study as a whole Partial equilibrium analysis examines

equilibrium conditions and dynamics of individual markets General equilibrium theory represents the

vision for modern theory Partial equilibrium analysis is a tool for policy

analysis

8.2.1 GCE and Efficiency

When the general system has reached an equilibrium –

Pareto optimality There is this ultimate efficiency that

Smith described as the power of the invisible hand

8.2.2 GCE and Distributive Justice

Efficiency and equity (fairness) are two different yardsticks

What is a “just distribution”? No scientific basis for answering that

question It is a values question

GCE and Distributive Justice

What markets will do in perfect competition makes sure each person gets the most out of his/her share of the social endowment

8.2.2 GCE and Distributive Justice

Figure 8.2.1 - Distribution of Society's Endowment and Distribution of Society's Product

C

D

A

B

C

D

A

B

Social Endowment Social Product

8.2.3 Changing Distributive Outcomes

If you think that the current system of distribution is unjust,

how do you change it without destroying efficiency?

Kenneth Arrow – Nobel Prize Change initial endowments rather than interfere

later on Even under the best situations for markets to

take care of everything, you still need to talk about who gets what

8.2.4 Commutative Justice and GCE

We have assumed the race is fair, no power advantages exist

Without certain rules, power can lead to destructive, rather than constructive, competition

So far, we’ve assumed market power simply didn’t exist

Our more realistic model will account for the fact that it does