MICROECONOMICS: Theory & Applications
Chapter 19: General Equilibrium Analysis
and Economic Efficiency
By
Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College
Learning Objectives

Delineate the difference between partial and
general equilibrium analysis.
 Explain the concept of economic efficiency.
 Outline the three conditions necessary for the
attainment of economic efficiency.
 Examine efficiency in production and what this
implies about input usage across difference
industries.
(continued)
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Learning Objectives
(continued)

Show how efficiency in output is related to the
production possibility frontier.
 Demonstrate how perfect competition satisfies
all three conditions for economic efficiency.
 Spell out the reasons why economic efficiency
may not be achieved.
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Partial and General Equilibrium
Analysis Compared

General equilibrium analysis – the study of
how equilibrium is determined in all markets
simultaneously

Partial equilibrium analysis – the study of
the determination of an equilibrium price and
quantity in a given product or input market
viewed as self-contained and independent of
other markets; assumes that some things
that conceivably could, but do not, change
(“other things equal”)
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The Mutual Interdependence of
Markets Illustrated

Spillover effect – a change in equilibrium in
one market that affect other markets

Feedback effect – a change in equilibrium in
a market that is caused by events in other
markets that, in turn, are the result of an initial
change in equilibrium in the market under
consideration
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Figure 19.1 - Interdependence Between
Markets: Butter and Margarine
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When Should General Equilibrium
Analysis Be Used?

Guideline:



Partial analysis is usually accurate in cases involving a
change in conditions primarily affecting one market among
many, with repercussions on other markets dissipated
throughout the economy
General equilibrium analysis tends to be more appropriate
when a change in conditions affects many, or all, markets
are the same time and to the same degree
Pareto optimal – the condition in which it is not
possible, through any feasible change in resource
allocation, to benefit one person without making
some other person or persons worse off
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Economic Efficiency

Efficient – Pareto optimal; an allocation of
resources when it is not possible, through any
feasible change in resource allocation, to benefit
one person without making any other person worse
off

Inefficient – the condition in which it is possible,
through some feasible reallocation of resources, to
benefit at least one person without making any other
person worse off
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Figure 19.2 - Welfare Frontier

A curve that separates welfare
levels that are attainable from
those that cannot be reached
given the available resources
 Every point lying on the
curve satisfies the
definition of economic
efficiency
 Every point lying inside the
curve represents an
inefficient allocation of
resources
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Efficiency as a Goal for Economic
Performance

The notions of efficient and inefficient resource
allocations emphasize the factors that affect the level
and distribution of well-being.

BUT, given the premise that each person is the best
judge of their own welfare,
we cannot conclude that any efficient position is
better than any inefficient position.
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Conditions for Economic Efficiency

Any economy must solve 3 fundamental
economic problems:




how much of each good to produce
how much of each input to use in the production of
each good
how to distribute goods among consumers
Condition for efficiency in the distribution of
goods:
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Figure 19.3 - Efficiency in Production

Edgeworth Production
Box – a diagram that
identifies all the ways
two inputs such as
labor and land can be
allocated between
industries in a
simplified economy
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The Production Contract Curve and
Efficiency in Production

Efficient resource allocations in input markets lies on
the contract curve which connects points of tangency
between isoquants.

Where the equilibrium lies on the contract curve
depends on the input prices.

A general equilibrium in competitive input markets will
occur at the point in which the slopes of the isoquants
are equal to one another, as well as the input price
ratio.
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Figure 19.4 – General Equilibrium
in Input Markets
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General Equilibrium in Competitive
Input Markets
The condition for cost minimization:

The slopes of the two input isoquants
must equal one another since both are
equal to the same input price ratio.
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The Production Possibility Frontier and
Efficiency in Output

The PPF shows the alternative combinations of two
goods that can be produced with fixed supplies of
inputs; it can be derived from the contract curve by
plotting various possible output combinations directly

Marginal rate of transformation (MRT) – the rate at
which one product can be “transformed” into another

At any point on the frontier, the slope, or MRT, equals
MCc/MCF
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Figure 19.5 - The Production Possibility
Frontier Revisited
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Efficiency in Output

Efficiency in output is attained when the rate at which
consumers are willing to exchange one good for
another (MRS) equals the rate at which one good can
be transformed into another (MRT):

It is always possible to change the output mix and
leave consumers better off whenever their common
marginal rates of substitution are not equal to the
marginal rate of transformation
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Figure 19.6 - Efficiency in Output
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Figure 19.7 – The PPF and the Gains
from International Trade
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Competitive Markets and Economic
Efficiency
Perfectly competitive markets satisfy the
3 conditions for economic efficiency:



an efficient distribution of products among
consumers
efficiency in production
efficiency in output
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Condition 1 and Condition 2

Condition 1: Efficient Distribution of
Products Among Consumers

Condition 2: Efficiency in Production
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Condition 3

Condition 3: Efficiency in Output
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“Invisible Hand” Theorem

Adam Smith

If perfect competition prevails, then all three
conditions for economic efficiency are
satisfied.

People pursuing their own ends in
competitive markets promote economic
efficiency.
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The Role of Information

When resources are efficiently allocated, it is
assumed that all the relevant information is known.

Consumers or producers adjust their behavior
based on prices.

Efficient responses occur in a market system
without anyone knowing why prices change.
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The Causes of Economic Inefficiency

Market power

Monopoly (output market)

Monopsony (input market)

Imperfect information
 Externalities/Public goods


Side effects borne by people not directly involved
in the market activities
May be harmful or beneficial
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