Chapter 8
General Competitive Equilibrium
(GCE)
8.1.1 Introduction
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We’ve seen product markets,
factor markets,
how each work
and how they are part of the web of
connections
8.1.1 Introduction
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Now we look at the system as a whole.
Analysis at this level is called
general equilibrium theory
8.1.2 GCE Concepts
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All markets are part of a simultaneous
system
All elements function as a part of a
larger whole,
like an ecosystem
8.1.2 GCE Concepts
Product markets are connected to one
another
 Through cross-price elasticities
 Ex. Substitutes and complements
8.1.2 GCE Concepts
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Factor markets are connected to one
another
Through elasticity of input substitution
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
8.1.3 GCE versus
Partial Equilibrium Analysis
The only givens are:
 Distribution of shares of social
endowment
 Individuals’ tastes
 Current technology
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
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
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
8.2.2 GCE and Distributive Justice
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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
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
8.2.2 GCE and Distributive Justice
Social Endowment
Social Product
C
B
C
D
A
B
D
A
Figure 8.2.1 - Distribution of Society's Endowment and Distribution of Society's Product
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
8.2.4 Commutative Justice and GCE
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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