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  • Print publication year: 2009
  • Online publication date: June 2012

3.2 - General Equilibrium

from PART III - THE MARKET SYSTEM

Summary

“[Irma Adelman] was an early proponent of simulation models. In addition to work with input-output and linear-programming models, she was one of the pioneers in developing computable general equilibrium (CGE) models and applying them to developing countries, especially for analysis of income distribution.”

Distinguished Fellow Citation for Irma Adelman

We have become quite familiar with Figure 3.2.1.1. We have used partial equilibrium analysis to focus on a single commodity, exploring how supply and demand determine an equilibrium quantity that is the market's answer to the resource allocation question.

We have also used Figure 3.2.1.1 to set up and solve an optimization problem in which society chooses that quantity of a single commodity that maximizes consumers' plus producers' surplus.

When the market's equilibrium output equals the socially optimal quantity, the market works well. There are situations, however, when we do not get the quantity that maximizes CS + PS. We label these situations a market failure. An obvious example is monopoly. It produces too little output and generates a deadweight loss.

But the focus on a single commodity is limiting. In fact, the market system uses supply and demand for each good or service to answer the fundamental production and distribution questions. In other words, there are many interacting markets (one for each commodity) simultaneously in operation.

If we monopolize one commodity, we cause a misallocation of resources in the monopolized market (too little is produced) and that reverberates into the other markets.

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