ECO 323 ASSIGNMENT TOPIC: LEON WALRAS AND THE DEVELOPMENT OF GENERAL EQUILIBRIUM THEORY

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CONTENT LEON WALRAS: LIFE AND WORKS WALRAS AND ALFRED MARSHALL AND THE MARKET ADJUSTMENT MECHANISM WALRASIAN GENERAL EQUILIBRIUM IN CONSUMPTION AND WALRAS LAW PARETO OPTIMALITY, GENERAL EQUILIBRIUM AND WELFARE ECONOMICS WALRAS CORRESPONDENT AND ITS IMPACT ON THE DISCIPLINE OF ECONOMICS

HIS LIFE:
Marie-sprit Lon Walras was a mathematical economist associated with the creation of general equilibrium theory, the son of French proto-marginalist economist and school administrator AntoineAuguste Walras; born on December 16, 1834 in vreux, Upper Normandy, France. Lon Walras soon followed his father's footsteps; he adopted his socialist policy doctrines on taxation and land reform in fact, outright land nationalization - believing that lands value will always increase and that rents from the land would be sufficient to support the nation without taxes as well as his main economic ideas (subjective value theory, mathematization of economics). Walras enrolled in Paris school of mines, but grew tired of engineering. He also tried careers as a bank manager, journalist, romantic novelist and clerk before turning to economics. Walras was greatly influenced by Augustin Cornout (a former classmate of his father) and through him Walras came under the influence of French rationalism and was soon introduced to the use of mathematics in economics. He was an economics professor at the University of Lausanne in Switzerland. Walras is credited for having founded what subsequently became known under the direction of his Italian disciple, the economist and sociologist Vilfredo Pareto, the Lausanne school. Walras eventually returned to the study and teaching of economics. In that scientific discipline Walras claimed to have found pleasures and joys like those that religion provides to the faithful. He retired from teaching in 1892. Walras suffered loneliness, senility and mental illness before his death on January 5, 1910 in Clarens, near Montreux, Switzerland at age 75.

HIS WORKS:
He was regarded as one of the three progenitors of Marginalist Revolution. However, he was not familiar with the other two leading figures of marginalism, Stanley Jevons and Carl Menger and developed his themes independently. What distinguished Walras was his general equilibrium theory. Walras was appointed to the Academy of Lausanne in 1970. It was there that he wrote and published the first edition of his magnum opus Elements of Pure Economics in 1874, (three years after Jevons and Menger) and 1877 where he set out to solve a problem that was presented by Cornout, that even though it could be demonstrated that prices would equate supply and demand to clear individual markets, it was unclear that equilibrium existed for all markets simultaneously. Walras created a system of simultaneous equations in an attempt to solve Cornouts problem. He built a system of simultaneous equations to describe his hypothetical economy, a tremendous task and then showed that because the number of equations equalled the number of unknowns, the system could be solved to give the equilibrium prices and quantities of commodities. The demonstration that price and quantity were uniquely determined for each commodity is considered one of Walras greatest contributions to economic science. However, Walras was aware that such equations could be solved mathematically for equilibrium did not mean in the real world it would ever reach that equilibrium, a process he called tatonnement or groping process. Tatonnement was a trial and error process in which a price was called out and people in the market said how much they were willing to demand or supply at that price. If there was an excess supply over demand then the price would be lowered so that less would be supplied and more demanded. Thus, would the prices grope toward equilibrium? Walras assumed highly unrealistically that no exchanges were made until equilibrium was reached.

The crucial step was Walras law which states that considering any particular market, if all other markets in the economy are in equilibrium then that specific market must also be in equilibrium. Walras law hinges on the mathematical notion that excess market demands (or inversely excess market supplies) must sum up to zero. This means that in an economy with n markets, it is sufficient to solve n-1 simultaneous equations for market clearing. Taking one good as the numeraire in terms of which prices are specified, the economy has n-1 prices that can be determined by the equation, so equilibrium should exist. A more rigorous version of the argument was developed by Kenneth Arrow and Gerard Debreu in the 1990s. Walras compiled the rest of the remaining volumes of his grand work - the studies in Social Economics (1896) and the studies in Applied Economics (1898). He envisaged these works to be complementary to the Elements and considered the three volumes as integral and essential pillars for his theory. Tellingly, the first is subtitled "theory of the division of social wealth" and the second "theory of the production of social wealth" whereas the Elements are subtitled merely "theory of social wealth". Unfortunately, most economists dismissed these last two volumes as 'light' stuff or, worse, a mere platform for socialist politics. Today, as then, the Elements alone is regarded as his Walras's only 'true' contribution. However, some economists continue to believe that, because his other two volumes were not taken into account, modern Neo-Walrasian general equilibrium theory has not adhered to Walras's original vision, either in general purpose or in detail. Modern economists have also dismissed Walras's attempt, in a later (1896) edition of the Elements, to take credit for the discovery of the marginal productivity theory of distribution (and denouncing Wicksteed's claim to priority), not only as lacking any basis in truth but even as mean-spirited. It is widely acknowledged that Walras learnt this theorem from Enrico Barone although, in a striking coincidence, Walras had been handed the theorem on a piece of paper from the Lausanne mathematician, Hermann Amstein, in 1877, but had not understood the mathematics well enough to make heads or tails out of it!)

WALRASIAN ADJUSTMENT
A market adjustment mechanism in which price rises when there is excess demand and falls when there is excess supply. Strictly speaking, these excess supplies and demands are those that would obtain without any history of disequilibrium, as with a Walrasian auctioneer. Leon Walras theorized that economic agents adjust prices (rather than quantities, per Alfred Marshall) to clear competitive markets that are out of equilibrium. Disequilibrium exists if, at the current price, the quantity demanded differs from the quantity supplied so that a market experiences a surplus or a shortage. In a Walrasian adjustment, the price will adjust until the quantity supplied and the quantity demanded is equal. Prices rise in response to a shortage, and fall in response to surpluses. Contrast with the Marshallian adjustment mechanism, which posits that the quantity supplied falls to cure a surplus, and the quantity supplied increases to cure shortages.

WALRASIAN GENERAL EQUILIBRIUM IN CONSUMPTION AND WALRAS LAW

General equilibrium is a branch of theoretical economics and originally a microeconomic theory that seeks to explain the behaviour of supply, demand and prices in a whole economy with interacting markets by seeking to prove that a set of prices exist that yield overall equilibrium. It was developed by the Leon Walras a French economist in his work elements of pure economics in 1874. It is in contrast to partial equilibrium which only analyses single markets. General equilibrium analysis addresses precisely how these vast numbers of individual and seemingly separate decisions aggregate in a way that coordinates productive effort, balances supply and demand, and leads to an efficient allocation of goods and services in the economy. It is also referred to as Walrasian general equilibrium. Within this orderly world, researchers have established additional restrictions on utility functions and production relations guaranteeing the existence of a unique Walrasian equilibrium, that is, a unique set of relative prices and corresponding demand and supply quantities at which, assuming fulfilled expectations, all consumers are maximizing their utility, all firms are maximizing their profits, and all markets clear. A Simple Illustrative Walrasian General Equilibrium Model

The economy at time t0 consists of n utility-maximizing never-satiated consumers, i = 1, . . . , n, and two profit-maximizing firms, X and Y . Each consumer is endowed with labour, capital, an ownership share in firm X, and an ownership share in firm Y. During period T the firms X and Y produce distinct consumption goods x and y, respectively, using labour services and capital services purchased from consumers at the beginning of period T. The consumption goods are sold to the consumers at the end of period T, and all profits are distributed back to the consumers as dividends in proportion to their ownership shares. Each consumer i maximizes his period T utility subject to physical feasibility constraints and a budget constraint, conditional on an expected dividend and on expected prices (i.e. goods prices, a wage rate, and a capital rental rate). Suppressing dependence on exogenously specified endowments and tastes (utility functions), the solutions to these consumer utility maximization problems give the demands and supplies for consumers as a function of expected dividends and expected prices. Each firm X and Y maximizes its period T expected profits subject to non-negativity and technology constraints, conditional on expected prices. Suppressing dependence on the exogenously specified technology, the solutions to these profit maximization problems give the demands and supplies of firms as a function of expected prices.

DEFINITION: A specific vector e* comprising of consumer supplies and demands for services and
consumption goods, firm demands and supplies for services and consumption goods, prices, expected prices, and expected dividends is said to be a Walrasian equilibrium if the following three conditions hold: (a)Individual Optimality: At e* each consumer i is maximizing his utility, conditional on expected prices and expected dividends, and each firm X and Y is maximizing its profits conditional on expected prices. (b) Fulfilled Expectations: At e* expected prices coincide with actual prices and expected dividends coincide with actual dividends calculated as consumer shares of firm profits. (c) Market Clearing: At e* excess supply is greater than or equal to zero in each market for each service and consumption good. Given conditions (a) and (b), it follows directly from a summation of all consumer budget constraints (with fulfilled expectations) that the economy satisfies a weak form of Walras Law at e* i.e., the total value of excess supply is non-negative. Consequently, the assumed non-satiation of consumers which implies that consumers satisfy their budget constraints as equalities; suffices to guarantee that

Walras Law holds at e* in the stronger sense that the total value of excess supply is zero. Condition (c) then yields the further implication that any service or consumption good in excess supply at e* must have a zero price.

WALRAS LAW
Walras' Law implies that the sum of the values of excess demands across all markets must equal zero, whether or not the economy is in a general equilibrium. This implies that if positive excess demand exists in one market, negative excess demand must exist in some other market. Walras Law is a principle in general equilibrium theory asserting that budget constraints imply that the values of excess market demands (or, conversely, excess market supplies) must sum to zero. That is, i PiXDi = i PiXSi = 0. Walras' Law is named after the economist Lon Walras, although the concept was expressed earlier but in a less mathematically rigorous fashion by John Stuart Mill in his Essays on Some Unsettled Questions of Political Economy (1844). Walras noted the mathematically equivalent proposition that when considering any particular market, if all other markets in an economy are in equilibrium, then that specific market must also be in equilibrium. The term "Walras' Law" was coined by Oskar Lange to distinguish it from Say's Law. Walras law corrects the math in Says Law. He developed the general equilibrium theory that argued that one MUST consider interdependency; NO ceteris paribus. Price changes do NOT happen in a vacuum; price had to change because either supply or demand changed in a significant way. In particular, when prices change, other things adjust automatically. The money market does not clear because Walras only considered markets for goods and services. 1. XD = XS Shortage in one market means a glut in at least one other market Point: - surplus relative price is too high in that market for it to clear, so it must be that some other market has a relative price that is too low 2. All Markets are clearing. Price of SHMOO is price of labor you must give up in order to Buy SHMOO. 3. Emphasize Price Adjustments, the person who sets the price is a Walrasian Auctioneer, but in a perfectly competitive market, no firm has the power to alter the price Walras' Law is ensured if every agent's budget constraint holds with equality. An agent's budget constraint is an equation stating that the total market value of the agent's planned expenditures, including saving for future consumption, must be less than or equal to the total market value of the agent's expected revenue, including sales of financial assets such as bonds or money. When an agent's budget constraint holds with equality, the agent neither plans to acquire goods for free (e.g., by stealing), nor does the agent plan to give away any goods for free. If every agent's budget constraint holds with equality, then the total market value of all agents' planned outlays for all commodities (including saving, which represents future purchases) must equal the total market value of all agents'

planned sales of all commodities and assets. It follows that the market value of total value of excess demand in the economy must be zero, which is the statement of Walras' Law.

PARETO OPTIMALITY
French economist, Leon Walras is said to have revolutionized economics with his rigorous mathematical formulation of the mechanics of the price system. Before Walras, economists had made little attempt to show how a whole economy with many goods fits together and reaches equilibrium. Walras goal was to do this. He did not succeed, but he took some major first steps. First, he built a system of simultaneous equations to describe his hypothetical economy, a tremendous task, and then showed that because the number of equations equalled the number of unknowns, the system could be solved to give the equilibrium prices and quantities of commodities. The demonstration that price and quantity were uniquely determined for each commodity is considered one of Walrass greatest contributions to economic science. Pareto showed that in the case of a fixed supply of goods, a welfare optimum in exchange would occur when no individual could benefit from trade without injuring someone else. A more specific formulation of Paretos point could be given by identifying a marginal rate of substitution. For any individual, the marginal rate of substitution between any two individuals- say x and y- measures the number of units of y that must be sacrificed per unit of x so that the level of satisfaction remains the same.( The marginal rate of substitution is the slope of the indifference curve.) A pareto optimum in exchange requires that the marginal rate of substitution between any pair of consumer goods be the same for any two individuals (selected at random). If this is not the case, then one or both parties could gain from exchange. Exchange is Pareto optimal in other words, as long as at least one of the parties to the trade is made better off without leaving the other party worse off. We also have the Paretian factor substitution. The marginal rate of factor substitution or marginal rate of technical substitution(In microeconomic theory, the slope of an isoquant)measures the number of units of an input i that can be substituted for another input j in such a way as to maintain a constant level of output. Pareto stated the conditions necessary for the optimum distribution of resources, given a fixed supply of inputs. The Pareto condition is that the marginal rate of technical substitution between any pair of inputs must be the same for all producers (chosen at random) who use both inputs. If not, reallocation of inputs could result in larger total output without a reduction in the output of any single commodity. An optimum further implies that each factor receives a wage equal to the value of its marginal product, a state of affairs that occurs under perfect competition.

General-Equilibrium Analysis
Lon Walras set forth the new "Marginalist" or "Neoclassical" theory in a formal general equilibrium setting. He endowed it with the multi-market considerations Stanley Jevons had largely avoided and the mathematical precision Carl Menger had eschewed. He is widely and rightfully regarded as the father of general equilibrium theory.

Walras ignored historical processes and institutional arrangement, but supported the greater use of abstract reasoning in mathematical forms. Walras's biggest contribution was in what is now called general equilibrium theory. From his book, Elements of Pure Economics (1874),general equilibrium theory seeks to explain production, consumption and prices in a whole economy. Walras claimed that market reaches its equilibrium through price adjustment, in which the Walrasian auctioneer (introduced by Leon Walras) is the presumed auctioneer that matches supply and demand in a market of perfect competition. The process is called ttonnement relating to finding the market clearing price.

Walrasian Price Adjustments and General Equilibrium Specified as: wL+rN+iK+ E = NI = GDP = C + I + G + (X-M) = C + S + T

WELFARE ECONOMICS
Walrasian equilibrium allocation is said to be a Pareto optimal allocation. We then prove a converse result that if an initial allocation is Pareto optimal; there is a Walrasian equilibrium at which no trade occurs. Basic questions in general equilibrium analysis are concerned with the conditions under which equilibrium will be efficient, which efficient equilibria can be achieved, when an equilibrium is guaranteed to exist and when the equilibrium will be unique and stable. There are said to be two theorems of welfare economics: The First Fundamental Welfare Theorem asserts that market equilibria are Pareto efficient. In a pure exchange economy, a sufficient condition for the first welfare theorem to hold is that preferences be locally nonsatiated. The first welfare theorem also holds for economies with production regardless of the properties of the production function. Implicitly, the theorem assumes complete markets and

perfect information. In an economy with externalities, for example, it is possible for equilibria to arise that are not efficient. The result provides formal support for Adam Smiths claim that individuals acting in their own interests end up behaving in a way that is efficient from a societal standpoint. It is a powerful statement about the efficiency properties of decentralized markets: despite the fact that there is no explicit social coordination and agents simply maximize their utilities given prices, the resulting equilibrium outcome is efficient from a social perspective. The first welfare theorem is informative in the sense that it points to the sources of inefficiency in markets. Under the assumptions above, any market equilibrium is tautologically efficient. Therefore, when equilibria arise that are not efficient, the market system itself is not to blame, but rather some sort of market failure. (Note that in a sense, the assumptions are quite weak.) Second Fundamental Theorem of Welfare Economics: While every equilibrium is efficient, it is clearly not true that every efficient allocation of resources will be in equilibrium. However, the second theorem states that every efficient allocation can be supported by some set of prices. In other words, all that is required to reach a particular outcome is a redistribution of initial endowments of the agents after which the market can be left alone to do its work. This suggests that the issues of efficiency and equity can be separated and need not involve a trade-off. The conditions for the second theorem are stronger than those for the first, as consumers' preferences now need to be convex (convexity roughly corresponds to the idea of diminishing rates of marginal substitution, or to preferences where "averages are better than extremes"). Note that the second welfare theorem does not say that starting from a given endowment, every Pareto optimal allocation is a Walrasian equilibrium. Rather it says that if we were to start from a given endowment then for any Pareto optimal allocation there is a way to re-distribute resources and a set of prices that makes the allocation a Walrasian equilibrium outcome.

WALRAS CORRESPONDENCE AND ITS IMPACT ON THE DISCIPLINE OF ECONOMICS.

Leon Walras was a true believer in the system that he developed and he attempted to convert economists and policymakers all over the world to the general-equilibrium faith. Between 1857 and 1909, he communicated with virtually every major economist in the world. The definitive collection of Walras extraordinary correspondence was published in 1965 and was edited by Professor William Jaffe. With precise care and astounding scholarship, Jaffe selected, edited and commented upon almost eighteen hundred of Walras letters (from a still larger correspondence) dealing with economic analysis, with the profession of economics and with the enormous array of topics that interested Walras. A search through the correspondence reveals the many sides of Walras: his petty debates over the priority of theoretical ideas; his general contempt for English economists (especially Mill and Marshall); his personal lobbying for a Nobel Peace Prize in recognition of his scientific discoveries and their alleged application to society and social problems; his evaluation of theoretical criticism of his system and his arguments on mathematical economics as the mainspring of social reform. However, we find Walras marketing and advertising the general equilibrium system here lobbying shamelessly with journal editors for summaries of his system to be printed, there on the offensive, attacking partial equilibrium analysis.

As revealed in the Correspondence, Walras was willing to make significant sacrifices in the course of spreading his conception of economic science. He was concerned not only with the errors he perceived in others writings that should be corrected but also that his own place be established in the profession. In a letter of April 11, 1893, to his student Vilfredo Pareto, Walras noted that it would give him .............great pleasure to have others eventually recognize that only Gossen, Jevons and I have conceived the degree of utility as the central element in valuation and that alone have demonstrated the proportionality of the final degrees of utility to all exchanges, prices or values to the state of general equilibrium and production. And as for Dupuit, Menger, Wieser, Bohm Bawerk, Auspitz and Lieben, Marshall, Edgeworth and all the rest, they have confused price and the final degree of utility through identification of the curve of utility and the demand curve (Correspondence, II, letter 1123). In more general terms, Walras correspondence is a shimmering mirror of a most unusual man, his era, and the birth of the international cultivation of the science of economics. Although some of the issues taken up in the Correspondence seem frivolous, they are nevertheless issues that helped shape the modern profession of economics. Walras unflinching attempt to sell economics as a science was a primary force that helped to mould the character of the discipline in the twentieth century. The barriers of national interests and separate languages tended to fall away with the increasingly mathematical character of the science. More than any other single economist, Leon Walras established and sold an analytical method whose cultivation transcended national boundaries. How he did so is in itself fascinating, but Walras was an economist whose analytical invention placed him among the giants of the field.

Impact on the discipline of economics

Walras most original contribution to economics was his mathematical specification of a generalequilibrium system. Such a system stresses the wide and complex web of interrelations in a modern economy. It may be contrasted with partial-equilibrium analysis, which ignores such interrelations in order to focus on specific firms or individuals. Before Walras, Cournot had pointed out that a complete and rigorous solution of the problems relative to specific parts of the economic system requires consideration of the entire system and its interconnections. Even before Cournot, Quesnay had presented a clear vision of the economy consisting of many interconnected parts. But Cournot thought the problem of general equilibrium was beyond the reach of mathematical analysis, and Quesnay never got as far as a mathematical specification of microeconomic relations. Walras genius lay in his grasp of the problem anticipated by Quesnay and Cournot and in his demonstration that the problem was solvable, at least in principle. It is generally held by most economists that Walras contribution was one of form more than of substance. The pattern of the system is precise, but Walras did not undertake the vast statistical research necessary to provide concrete solutions to each of the equations in the system. There are, in fact, tremendous problems in specifying the relevant equations in precise terms and in gathering data on such a large scale. The recognition of such problems is not meant to diminish the importance of Walras contribution. Himself a mediocre mathematician, Walras in any case, demonstrated the power of mathematics in solving complex theoretical problems. He made it possible, moreover, to see that equilibrium of the household and the markets for final goods was consistent with equilibrium of the firm and factor markets.

CONCLUSION:
In conclusion, the Walrasian general equilibrium model demonstrates how price systems are capable, in principle, of coordinating the supplies and demands of private agents in models of decentralized market economies that assume all agents are price takers. However, the Walrasian general equilibrium model is incomplete as a model of real-world decentralized market economies, since many private agents in such markets are price setters. General equilibrium model contains exercises in mathematics without any connection to actual economies. According to Nicholas Georgescu Roegen in 1979; They are endeavours that now pass for the most desirable kind of economic contributions, although they are just plain mathematical exercises, not only without economic substance but also without any mathematical value. He cites an example on a paper that assumes more traders in existence than points in a set of real numbers. In a real economy, trading as well as production and consumption goes on out of equilibrium. It follows that in the course of convergence (assuming that occurs) endowment changes. This in turn changes the set of equilibriums. That is the set of equilibriums becomes path dependent. This makes the calculation of the equilibriums corresponding to the state of the system essentially irrelevant. According to Franklin fisher as quoted in Petri (2004), what matters is the equilibrium that the market will reach from a given initial endowments, not the equilibrium it would have been in given the initial endowments. Critics hold that the conditions necessary for prices in a market to converge to general equilibrium is extremely strong. Keynesian and post Keynesian economists and their underconsumptionist predecessors criticize general equilibrium theory particularly because of the fact that it is neither useful nor accurate. They argue that economies are not in equilibrium and that the process of achieving equilibrium in an economy is often painful and slow. They also argue that modelling in general equilibrium is often misleading. Neoclassical macroeconomic reasoning concludes that because of Walras' Law, if all markets for goods are in equilibrium, the market for labour must also be in equilibrium. Thus, by neoclassical reasoning, Walras' Law contradicts the Keynesian conclusion that negative excess demand and consequently, involuntary unemployment, may exist in the labour market, even when all markets for goods are in equilibrium. The Keynesian refutation is that this neoclassical perspective ignores financial markets, which may experience excess demand (e.g., a Keynesian liquidity trap for money) that permits an excess supply of labour and consequently, temporary involuntary unemployment, even if markets for goods are in equilibrium.

REFERENCES:
Wikipedia, the free encyclopaedia General equilibrium Jonathan Levin International economic review Vol. 7, No. 3, September, 1966 - Walras' law, Say's law and liquidity preference in general equilibrium analysis by S. C. TSIANG Investopaedia Jaff, William, and Donald A. Walker (ed.) (1983). Essays on Walras. Cambridge University Press (page 34-39) History of economic thought by Ekerlund and Herbert