Equilibrium Analysis in

Economics

Equilibrium
Static Analysis
Partial Market Equilibrium
General Equilibrium

Equilibrium
Equilibrium is a constellation of
selected interrelated variables so
adjusted to one another that no
inherent tendency to change prevails
in the model which they constitute

Equilibrium
Selected
Some variables are not selected to be in
the model
Equilibrium is relevant only to the
selected variables and may no longer
apply if different variables are included
(excluded)

Equilibrium
Interrelated
Since the variables are interrelated, all
the variables must be in a state of rest if
equilibrium is to be achieved

Inherent
The state of rest refers to the internal
forces of the model; external forces
(exogenous variables) are assumed fixed

Equilibrium
Since equilibrium refers to a lack of
change, we often refer to equilibrium
analysis as static analysis or statics

Partial Market Equilibrium

Constructing the model
An equilibrium condition, behavioral
equations, and restrictions must be
specified
Qd = Qs
Qd = a - bP (a, b > 0)
Qs = -c + dP (c, d > 0)

Partial Market Equilibrium

Solving the model
Equilibrium tells us Qd = Qs so we can
substitute into the equilibrium equation
and solve

a - bP = -c + dP
a + c = bP + dP
a + c = P(b + d)
a + c = P (equilibrium price)
b+d

Partial Market Equilibrium

Note the solution is entirely in the
form of parameters - this is typical
P is positive (as required by
economics)
a, b, c, d > 0 therefore
a + c > 0 as well
b+d

Partial Market Equilibrium

Find the equilibrium quantity by
substituting the equation for price
into one of the equations for Q
Q=a-b*a+c
b+d
Q = a(b + d) - b * a + c
b+d
b+d

Partial Market Equilibrium

Q = ab + ad - ba - bc
b+d
Q = ad - bc
b+d

The equilibrium value of Q should be > 0

b + d > 0 since b, d > 0
We have added restriction of ad > bc for
Q>0

Partial Market Equilibrium

Suppose we have the following
model which results in a quadratic
Qd = Qs
Qd = 4 - P2
Qs = 4p - 1

Partial Market Equilibrium

Setting up equation to solve gives us
4 - P2 = 4P - 1
P2 + 4P - 5 = 0
The left-hand expression is a
quadratic function of the variable P
Can use the quadratic formula to
solve the equation

Partial Market Equilibrium

General form of a quadratic equation is:
ax2 + bx + c = 0

Using the quadratic formula, two roots

can be obtained from a quadratic
equation, x1 and x2
x1 and x2 provide solutions
x1, x2 = -b + and - (b2 - 4ac)1/2
2a

Partial Market Equilibrium

Our expression is: P2 + 4P - 5 = 0
P1, P2 = -4 + and - (42 - 4(1)(-5))1/2
2(1)
P1, P2 = -4 + and - (16 + 20)1/2
2
P1, P2 = -4 + and - 6
2

Partial Market Equilibrium

P1 = -4 + 6
2
2
P1 = -2 + 3 = 1
P2 = -4 - 6
2 2
P2 = -2 -3 = -5
Only P1 is relevant since P > 0

Partial Market Equilibrium

If P = 1 then Q =4P - 1 = 3

General Equilibrium Model

Our analysis can extend to n
commodities
There will be an equilibrium
condition for each of the n markets
There will be behavioral equations
for each of the n markets

General Equilibrium Model

Equilibrium conditions
Qd1 = Qs1
Qd2 = Qs2
.
.
.
.
.
.
Qdn = Qsn

General Equilibrium Model

Behavioral equations
Qd1 = a0 + a1P1 + a2P2 + + anPn

Qs1 = b0 + b1P1 + b2P2 + + bnPn

Qd2 = c0 + c1P1 + c2P2 + + cnPn
Qs2 = d0 + d1P1 + d2P2 + + dnPn
Qdn = 0 + 1P1 + 2P2 + + nPn
Qsn = 0 + 1P1 + 2P2 + + nPn

General Equilibrium Model

Such a system is very difficult to
solve with the method of substitution
Can use matrix algebra to solve a
system of linear equations