Lecture-11 - history of economic thought course.ppt

this presentation is intended for the history of economic thought course

1. 11
Azerbaijan University 2023
Lecture
General Equilibrium ModelGeneral Equilibrium Model
History of Economic Thought
Instructor: Tural L. Gojayev
11

2. 2© 2023 Tural L. Gojayev
CONTENTS
General Equilibrium Model and History of
Economic Thought
General Equilibrium Model and its
significance.
 Existence, uniqueness and stability of
equilibrium.
The social implications of the general
equilibrium theory.

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General Equilibrium Model and
history of economic thought
The development of the general equilibrium
model represents a significant milestone in the
history of economic thought. It evolved as
economists sought to understand how markets
interact and how prices are determined across
various goods and factors of production within
an economy.
© 2023 Tural L. Gojayev

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General Equilibrium Model and its
significance.
The General Equilibrium Model (GEM) is a
fundamental concept in economics that aims to
analyze the interactions between various
markets within an economy. It's a theoretical
framework used to understand how supply,
demand, prices, and quantities are interrelated
across multiple markets simultaneously
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Key Components of the General
Equilibrium Model:
Interconnected Markets: “GEM” considers the
interconnectedness of markets, recognizing that
changes in one market can impact others. It examines
the relationships among goods, services, factors of
production, and financial assets.
Supply and Demand: Similar to microeconomic
analysis, GEM involves supply and demand interactions
in multiple markets. It looks at how changes in one
market (e.g., increase in demand for a good) affect other
related markets (e.g., demand for inputs or substitutes).
© 2023 Tural L. Gojayev

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Equilibrium:
Equilibrium: GEM focuses on identifying a state
of equilibrium where all markets clear
simultaneously. This equilibrium occurs when
the quantity demanded equals the quantity
supplied in every market, leading to stable
prices and quantities across the economy.
© 2023 Tural L. Gojayev

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Significance of the General
Equilibrium Model:
Comprehensive Analysis: It provides a comprehensive framework for
understanding how different sectors of an economy interact. This helps in
evaluating policy changes, technological advancements, or external shocks'
impacts on various markets.
Efficiency and Allocation: GEM allows economists to analyze the efficiency and
allocation of resources within an economy. It examines whether resources are
efficiently distributed among different sectors or if there are inefficiencies that need
addressing.
Policy Implications: Policymakers use GEM to assess the potential outcomes of
policy interventions. By simulating changes in various markets, economists can
predict the possible effects of policies on prices, quantities, and overall welfare.
Understanding Complex Economies: Modern economies are complex and
interconnected. GEM provides a way to model this complexity, making it a valuable
tool for understanding real-world economic phenomena.
Basis for Further Research: GEM serves as a foundation for advanced economic
research, enabling the development of more sophisticated models to address
specific economic questions or phenomena.
© 2023 Tural L. Gojayev

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Existence, uniqueness and stability
of equilibrium.
General equilibrium theory in economics is a
framework that examines the interactions among
various markets in an economy to determine the
prices of goods and factors of production, as
well as the allocation of resources. There are
three key concepts associated with general
equilibrium: existence, uniqueness, and stability.
© 2023 Tural L. Gojayev

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Existence:
Existence: This concept addresses whether an
equilibrium solution exists in a given economic
model. In a general equilibrium model, an
equilibrium is reached when the supply and
demand for goods and services, as well as for
factors of production, are balanced across all
markets. Proving the existence of a general
equilibrium involves demonstrating that there is
a set of prices for goods and factors that clears
all markets simultaneously.
© 2023 Tural L. Gojayev

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Uniqueness:
Uniqueness: Uniqueness refers to whether
there is only one equilibrium solution in the
model. In some cases, multiple sets of prices
and allocations may satisfy the conditions for
equilibrium. Establishing uniqueness involves
demonstrating that there is only one such set of
prices and allocations that fulfills all market-
clearing conditions.
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Stability:
Stability: Stability concerns the behavior of the
economic system when it experiences
disturbances or shocks. A system is considered
stable if, after being perturbed from its
equilibrium, it returns to the equilibrium over
time. Stability analysis involves studying the
reactions of markets to changes in prices or
other exogenous factors and assessing whether
the system tends to revert to its initial
equilibrium.
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These concepts are crucial in understanding the
properties of general equilibrium models. The
proofs for existence, uniqueness, and stability
often rely on mathematical and economic
arguments that demonstrate the conditions
under which equilibrium can be established, its
characteristics, and its resilience to changes.
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General equilibrium theory helps economists
understand how markets interrelate and how
changes in one market can affect others,
providing insights into the efficiency and
functioning of an economy. However, the real-
world economy is often complex and dynamic,
and the assumptions underlying these models
may not fully capture all real-world complexities.
Thus, while general equilibrium theory provides
valuable insights, it's essential to consider its
limitations and potential deviations from reality.
© 2023 Tural L. Gojayev

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The social implications of the general
equilibrium theory.
The general equilibrium theory has several
social implications that influence how
economists and policymakers understand and
address various societal issues:
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Efficiency:
Efficiency: One of the primary implications is
the concept of Pareto efficiency, where
resources are allocated in such a way that it's
impossible to make anyone better off without
making someone else worse off. This notion
guides policymakers in evaluating economic
policies and interventions to maximize societal
welfare.
© 2023 Tural L. Gojayev

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Welfare Economics
Welfare Economics: General equilibrium theory
provides a framework for analyzing the
distribution of resources and welfare across
society. It helps in understanding how different
policies or market structures affect the overall
welfare of individuals and groups within an
economy.
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Market Failures:
Market Failures: By examining the conditions
for equilibrium, the theory highlights situations
where markets may fail to allocate resources
efficiently. This includes cases of externalities
(like pollution), public goods provision,
asymmetric information, and monopolies.
Understanding these failures is crucial for
designing policies to correct or mitigate these
inefficiencies.
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Income Distribution
Income Distribution: The theory can inform
discussions about income distribution and
inequality. It helps in assessing how changes in
market conditions or policies affect different
income groups and can guide policymakers in
designing measures to address inequality.
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Policy Design:
Policy Design: Policymakers often use general
equilibrium models to assess the potential
impacts of policy changes. Whether it's tax
reforms, trade policies, or social welfare
programs, these models can provide insights
into the broader effects on the economy and
different segments of society.
© 2023 Tural L. Gojayev

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Globalization and Trade
Globalization and Trade: The theory plays a
crucial role in understanding the implications of
globalization and international trade. It helps in
analyzing the effects of trade policies, such as
tariffs or trade agreements, on the allocation of
resources, employment, and overall welfare of
nations.
© 2023 Tural L. Gojayev

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Social Welfare Programs
Social Welfare Programs: Analysis through
general equilibrium models helps in evaluating
the effectiveness and potential unintended
consequences of social welfare programs. It
allows policymakers to anticipate how these
programs might influence behavior, employment,
and overall economic dynamics.
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However, it's important to note that while the
general equilibrium theory provides valuable
insights, its assumptions (perfect competition,
rational behavior, etc.) may not always align with
the complexities of the real world. As a result, its
implications should be interpreted with caution,
considering the limitations and potential
deviations from reality when applying these
models to real-world situations.
© 2023 Tural L. Gojayev