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Partial Equilibrium vs. General Equilibrium Approach
Introduction
In economics, equilibrium analysis helps us understand how markets function and how prices and quantities are determined. There are two main approaches:
✔ Partial Equilibrium Approach – Examines a single market in isolation.
✔ General Equilibrium Approach – Analyzes multiple markets simultaneously and their interdependencies.
This blog explores the differences, advantages, limitations, and real-world applications of both approaches.
1. Partial Equilibrium Approach
📌 Definition
Partial equilibrium focuses on one market at a time, assuming all other markets remain constant (ceteris paribus assumption).
📌 Key Features
✔ Analyzes demand and supply in a single market.
✔ Assumes no interaction with other markets.
✔ Useful for simplified analysis of specific policies (e.g., a tax on a single good).
📌 Alfred Marshall’s Approach
- Marshallian analysis studies how price and quantity are determined in one market.
- Uses demand-supply diagrams to show market equilibrium.
🔹 Mathematical Representation Qd=f(P)Q_d = f(P) Qs=g(P)Q_s = g(P)
where QdQ_d and QsQ_s are demand and supply functions of a single good, independent of other markets.
📌 Graphical Representation
A standard demand-supply diagram shows equilibrium where demand equals supply.
📊 Diagram Explanation:
- X-axis: Quantity of the good.
- Y-axis: Price of the good.
- Equilibrium occurs where demand curve = supply curve.
📌 Example:
- The price of oranges is determined only by supply and demand for oranges, ignoring how price changes affect apple or banana markets.
📌 Advantages
✔ Simple and easy to apply.
✔ Useful for microeconomic policy analysis (e.g., effects of a subsidy or tax on one market).
✔ Helps firms determine optimal pricing and production decisions.
📌 Limitations
✖ Ignores interdependence between markets (e.g., if orange prices rise, apple demand may increase).
✖ Cannot analyze economy-wide effects of policies.
2. General Equilibrium Approach
📌 Definition
General equilibrium examines multiple markets together, considering how changes in one market affect and are affected by other markets.
📌 Key Features
✔ Analyzes the entire economy simultaneously.
✔ Considers interactions between goods, services, and factor markets.
✔ Developed by Léon Walras in Walrasian General Equilibrium Theory.
🔹 Mathematical Representation (Walrasian Model)
For multiple goods, we have: Qdi=f(P1,P2,…,Pn)Q_{d_i} = f(P_1, P_2, …, P_n) Qsi=g(P1,P2,…,Pn)Q_{s_i} = g(P_1, P_2, …, P_n)
where QdiQ_{d_i} and QsiQ_{s_i} are demand and supply functions for different goods, dependent on prices of other goods.
📌 Graphical Representation
A two-market model shows how equilibrium in one market depends on another.
📊 Diagram Explanation:
- Two demand-supply graphs connected, showing how equilibrium changes in one market shift the equilibrium in another.
📌 Example:
- If the wages of workers increase, consumers have more money to spend, increasing demand for cars, electronics, and food.
- A tax on petrol affects not just petrol demand but also transportation costs, inflation, and overall consumption patterns.
📌 Advantages
✔ Captures real-world complexity by considering multiple markets.
✔ Useful for macroeconomic policy decisions (e.g., tax policies, trade policies, and government spending).
✔ Explains how shocks spread across the economy (e.g., how an oil price rise affects all sectors).
📌 Limitations
✖ Highly complex and difficult to model.
✖ Requires advanced mathematical techniques (e.g., input-output models, computable general equilibrium models).
✖ Difficult to apply in short-term decision-making.
3. Key Differences Between Partial and General Equilibrium
| Feature | Partial Equilibrium | General Equilibrium |
|---|---|---|
| Scope | Single market analysis | Multiple markets analyzed together |
| Assumption | Other markets remain constant (ceteris paribus) | All markets interact and adjust together |
| Developed by | Alfred Marshall | Léon Walras |
| Complexity | Simple and easy to use | Highly complex |
| Best Used For | Microeconomic policies (e.g., price controls, tax on a single good) | Macroeconomic analysis (e.g., inflation, wage policy, economic shocks) |
| Example | Studying the impact of a tax on sugar | Studying the impact of oil price changes on wages, transportation, and production |
| Mathematical Model | Qd=f(P)Q_d = f(P), Qs=g(P)Q_s = g(P) | Qdi=f(P1,P2,…,Pn)Q_{d_i} = f(P_1, P_2, …, P_n), Qsi=g(P1,P2,…,Pn)Q_{s_i} = g(P_1, P_2, …, P_n) |
4. Real-World Applications
1. Government Policy Making
✔ Partial Equilibrium → Used for analyzing subsidies on wheat, price caps on rent.
✔ General Equilibrium → Used for analyzing tax policies, monetary policies, and international trade policies.
2. Business Strategy
✔ Partial Equilibrium → Firms set pricing strategies based on demand-supply conditions in their market only.
✔ General Equilibrium → Firms consider industry-wide and economy-wide factors such as wage rates, fuel costs, and inflation.
3. Trade and Global Economy
✔ Partial Equilibrium → Studies the impact of tariffs on one industry (e.g., steel).
✔ General Equilibrium → Examines how tariffs affect entire economies, including employment, wages, and inflation.
5. Conclusion
✔ Partial equilibrium is useful for simple, single-market analysis but ignores market interactions.
✔ General equilibrium provides a realistic, economy-wide view but is complex and difficult to model.
✔ Policymakers and businesses use both approaches depending on the scope of the problem.