Module 8 General equilibrium and market failure
Kb 1 General equilibrium of market mechanism
Partial market equilibrium shows the equilibrium conditions in each output or input
market based on the forces of demand and supply.
Market general equilibrium describes the same thing but as a whole by looking at the
impact of what happens in other markets in the economy. This shows the
interconnectedness of markets with each other.
In simple terms, general equilibrium can be described by the 2-output and 2-
input Market model. Equilibrium adjustments that occur due to changes in one
market will result in equilibrium changes in other markets. This adjustment can
occur in the short and long run. The first adjustment point does not include changes
in production capacity, only changes in market equilibrium prices and quantities.
If all the conditions and assumptions are met, a logical competitive market price
mechanism will lead to an optimal welfare outcome. These conditions are self-
interest fulfillment and competition conditions.
The input output table of a country's economy is an attempt to depict the close and
complex relationships between sectors, industries or markets in a point economy
assuming that the production coefficients are constant, the table tries to depict the
output of a sector used as input, in other sectors. This table can be used to make
economic development planning coefficients.
The Pareto Optimum or the efficiency of resource allocation on the consumption
side can be described using the concept of the limit of possible use values. This point
is analogous to the concept of the production limit in a simple way, assuming there are
only two individual consumers who consume various bundles of combinations of
consumer goods. The line or curve of the limit of possible use values that is further
away from the origin to the right will show the achievement of higher use values or
satisfaction.
The consumer surplus shown by the individual demand curve is downward
sloping due to the operation of the law of diminishing returns, while the consumer
buys the commodity at the same price, namely the market price point Thus there is a
difference between the value of the benefits obtained and the price paid, which is
called consumer surplus. Consumers will continue to increase their purchases of
goods until the level at which the consumer surplus is not or where the use value
obtained from the consumption of the good is equal to the price.
Economic Rents or producer surplus is analogous to consumer surplus. This is
because Marginal cost slopes upwards while producers sell their output at the same
price i.e. market price. Producer surplus is the difference between the market price
and Marginal cost. The Marginal cost point in a purely competitive market
represents the producer's supply curve. Producers will produce up to the level of
output where the economic rent is not or where Marginal cost = price.
The settlement of the market equilibrium price and quantity which is the result
of the intersection of the demand curve and the supply curve provides an economic
surplus which is the maximum consumer surplus and producer surplus if the output
produced is greater or smaller than the equilibrium output then the economic surplus
obtained is not maximum. Therefore the economy suffers a dead weight loss
