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General equilibrium theory
In economics, general equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an overall general equilibrium. General equilibrium theory contrasts with the theory of partial equilibrium, which analyzes a specific part of an economy while its other factors are held constant.
General equilibrium theory both studies economies using the model of equilibrium pricing and seeks to determine in which circumstances the assumptions of general equilibrium will hold. The theory dates to the 1870s, particularly the work of French economist Léon Walras in his pioneering 1874 work Elements of Pure Economics. The theory reached its modern form with the work of Lionel W. McKenzie (Walrasian theory), Kenneth Arrow and Gérard Debreu (Hicksian theory) in the 1950s.
Broadly speaking, general equilibrium tries to give an understanding of the whole economy using a "bottom-up" approach, starting with individual markets and agents. Therefore, general equilibrium theory has traditionally been classified as part of microeconomics. The difference is not as clear as it used to be, since much of modern macroeconomics has emphasized microeconomic foundations, and has constructed general equilibrium models of macroeconomic fluctuations. General equilibrium macroeconomic models usually have a simplified structure that only incorporates a few markets, like a "goods market" and a "financial market". In contrast, general equilibrium models in the microeconomic tradition typically involve a multitude of different goods markets. They are usually complex and require computers to calculate numerical solutions.
In a market system the prices and production of all goods, including the price of money and interest, are interrelated: a change in the price of one good may affect the price of another good. Calculating the equilibrium price of just one good, in theory, requires an analysis that accounts for all of the millions of different goods that are available. It is often assumed that agents are price takers, and under that assumption two common notions of equilibrium exist: Walrasian, or competitive equilibrium, and its generalization: a price equilibrium with transfers.
Friedrich Hayek's influential essay "The Use of Knowledge in Society" (1945) articulated what scholars have since identified as a fundamental challenge to the informational assumptions underlying general equilibrium theory. Hayek argued that economic knowledge is inherently dispersed across countless individuals and often exists in tacit, context-specific forms that cannot be aggregated or centralized. This posed a problem for some models, whether Walrasian equilibrium theory or centralized economic planning, that presumes complete information or the possibility of gathering all relevant data in one place.
Hayek proposed that market prices serve as decentralized information signals, distilling complex local knowledge about preferences, resources, and opportunities into summary statistics that coordinate economic decisions across society without requiring centralized knowledge or direction. While predating the full Arrow-Debreu formalization (1954), Hayek's essay has been interpreted by subsequent economists both as a critique of the informational feasibility of perfect-information equilibrium models and as an explanation of how real-world market processes achieve coordination through price mechanisms despite pervasive ignorance and uncertainty. This perspective emphasizes economic processes and discovery over static equilibrium states.
The first attempt in neoclassical economics to model prices for a whole economy was made by Léon Walras. Walras' Elements of Pure Economics provides a succession of models, each taking into account more aspects of a real economy (two commodities, many commodities, production, growth, money). Some think Walras was unsuccessful and that the later models in this series are inconsistent.
In particular, Walras's model was a long-run model in which prices of capital goods are the same whether they appear as inputs or outputs and in which the same rate of profits is earned in all lines of industry. This is inconsistent with the quantities of capital goods being taken as data. But when Walras introduced capital goods in his later models, he took their quantities as given, in arbitrary ratios. (In contrast, Kenneth Arrow and Gérard Debreu continued to take the initial quantities of capital goods as given, but adopted a short run model in which the prices of capital goods vary with time and the own rate of interest varies across capital goods.)
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General equilibrium theory
In economics, general equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an overall general equilibrium. General equilibrium theory contrasts with the theory of partial equilibrium, which analyzes a specific part of an economy while its other factors are held constant.
General equilibrium theory both studies economies using the model of equilibrium pricing and seeks to determine in which circumstances the assumptions of general equilibrium will hold. The theory dates to the 1870s, particularly the work of French economist Léon Walras in his pioneering 1874 work Elements of Pure Economics. The theory reached its modern form with the work of Lionel W. McKenzie (Walrasian theory), Kenneth Arrow and Gérard Debreu (Hicksian theory) in the 1950s.
Broadly speaking, general equilibrium tries to give an understanding of the whole economy using a "bottom-up" approach, starting with individual markets and agents. Therefore, general equilibrium theory has traditionally been classified as part of microeconomics. The difference is not as clear as it used to be, since much of modern macroeconomics has emphasized microeconomic foundations, and has constructed general equilibrium models of macroeconomic fluctuations. General equilibrium macroeconomic models usually have a simplified structure that only incorporates a few markets, like a "goods market" and a "financial market". In contrast, general equilibrium models in the microeconomic tradition typically involve a multitude of different goods markets. They are usually complex and require computers to calculate numerical solutions.
In a market system the prices and production of all goods, including the price of money and interest, are interrelated: a change in the price of one good may affect the price of another good. Calculating the equilibrium price of just one good, in theory, requires an analysis that accounts for all of the millions of different goods that are available. It is often assumed that agents are price takers, and under that assumption two common notions of equilibrium exist: Walrasian, or competitive equilibrium, and its generalization: a price equilibrium with transfers.
Friedrich Hayek's influential essay "The Use of Knowledge in Society" (1945) articulated what scholars have since identified as a fundamental challenge to the informational assumptions underlying general equilibrium theory. Hayek argued that economic knowledge is inherently dispersed across countless individuals and often exists in tacit, context-specific forms that cannot be aggregated or centralized. This posed a problem for some models, whether Walrasian equilibrium theory or centralized economic planning, that presumes complete information or the possibility of gathering all relevant data in one place.
Hayek proposed that market prices serve as decentralized information signals, distilling complex local knowledge about preferences, resources, and opportunities into summary statistics that coordinate economic decisions across society without requiring centralized knowledge or direction. While predating the full Arrow-Debreu formalization (1954), Hayek's essay has been interpreted by subsequent economists both as a critique of the informational feasibility of perfect-information equilibrium models and as an explanation of how real-world market processes achieve coordination through price mechanisms despite pervasive ignorance and uncertainty. This perspective emphasizes economic processes and discovery over static equilibrium states.
The first attempt in neoclassical economics to model prices for a whole economy was made by Léon Walras. Walras' Elements of Pure Economics provides a succession of models, each taking into account more aspects of a real economy (two commodities, many commodities, production, growth, money). Some think Walras was unsuccessful and that the later models in this series are inconsistent.
In particular, Walras's model was a long-run model in which prices of capital goods are the same whether they appear as inputs or outputs and in which the same rate of profits is earned in all lines of industry. This is inconsistent with the quantities of capital goods being taken as data. But when Walras introduced capital goods in his later models, he took their quantities as given, in arbitrary ratios. (In contrast, Kenneth Arrow and Gérard Debreu continued to take the initial quantities of capital goods as given, but adopted a short run model in which the prices of capital goods vary with time and the own rate of interest varies across capital goods.)