1. Chapter 8 General Competitive Equilibrium (GCE)

2. 8.1.1 Introduction We’ve seen product markets, factor markets, how each work and how they are part of the web of connections

3. 8.1.1 Introduction Now we look at the system as a whole. Analysis at this level is called general equilibrium theory

4. 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

5. 8.1.2 GCE Concepts Product markets are connected to one another Through cross-price elasticities Ex. Substitutes and complements

6. 8.1.2 GCE Concepts Factor markets are connected to one another Through elasticity of input substitution

7. 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. 8.1.3 GCE versus Partial Equilibrium Analysis The only givens are: Distribution of shares of social endowment Individuals’ tastes Current technology

9. 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

10. 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

11. 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

12. 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

13. 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

14. 8.2.2 GCE and Distributive Justice

15. 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

16. 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