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Working Of The General Equilibrium System

Working of the General Equilibrium System
With respect to the above postulations, the economy is in the state of general equilibrium when the demand for every commodity and service is equal to the supply for it. Each consumer is presumed to spend his entire income on consumption, so his expenditure matches his income. His income in turn depends on the prices at which he is selling his productive services. Thus the demand of consumers for the various commodities depends upon their prices of services. Given the market structure the state of technology and aims of firms the price at which a commodity sells depends on its costs of production. The costs of production in turn depend on the quantities of the various productive services employed and the prices paid for them. Assuming constant returns to scale and identical cost conditions for all firms each producer will produce and sell that quantity of output at which the demand price for the commodity equals both the minimum average cost and marginal cost. Let us construct General Equilibrium model and find out where the point of equilibrium cuts.

The market is in the equilibrium at Point E where the market demand and supply curves D and S intercept in the diagram (1). It determines OP price at which OQm quantity of the product is purchased and sold in the market. There being identical cost conditions as represented in the diagram (2) each firm in the market produces and sells the commodity at the given price OP. it is in equilibrium when MC = MR and AC = AR at Point E1 producing OQ units of the commodity.

Given the state of technology and the profit maximization idea of the producers, the volume of a factor used in producing a product depends on the affiliation amidst the prices of that factor and of all other factors and on the prices of products. Each producer maximises his profits virtually to the verdict factor prices by employing diverse factors in such rations and volumes that their marginal revenue outputs are equal to their prices. Since there is full employment in the economy the markets for factors are in equilibrium when the total volume of factors presented and the total volume employed are equal, the equilibrium of the factor market are shown in the below diagrams (3) and (4).

In diagram (3), the price of a factor OP and its quantity ON are determined in the market by the interaction of its demand and supply curves D and S at Point E. Diagram (4) shows the supply curve of this factor to an individual firm is perfectly elastic and is the same as the marginal cost of that factor MFC. The firm will employ units of the factor at the given factor price OP where MFC = MRP and AFC = ARP to the firm. Such an equilibrium point is E1 at which it employs OM units of the factor.

Thus the economy is in general equilibrium when commodity prices make each demand equal to its supply and factor prices make the demand for each factor equal to its supply so that all product markets and factor markets are simultaneously in equilibrium. It is characterised by two conditions in which the set of prices in all product and factor markets is such that (A) All consumers maximise their satisfactions and all producers maximise their profits and (B) All markets are cleared which means that the total amount demanded equals the total amount supplied at a positive price both the product and factor markets.

The general equilibrium study of the economy has quite a few precincts. It is based on a number of impractical hypotheses which are divergent to real circumstances. Perfect competition the very foundation of this analysis is a fable. It is a static analysis. Manufacturers and customers certainly not act and think similar. Changes are captivating incessantly in their choices and inclination. There is no steady income to scale and no two factor services are consistent. Thus the conditions vary from producer to producer. Lastly, Prof. Stigler denotes general equilibrium as a misnomer. According to him, "No economic analysis has ever been general in the sense that it considers equilibrium studies as more inclusive than partial equilibrium studies, never that they are complete. Moreover, the more general the analysis, the less specific its content must necessarily be."

Uses of General Equilibrium Analysis
It is an image of fiscal equilibrium. It presents private enterprises' economy in equilibrium where customers are accustomed to a position of maximum fulfilment and the producers to that of maximum proceeds. There is no excess of resources and that economic efficiency is at maximum.

To understand the working of economic system, we can know whether the economy is functioning economically or whether there is any incompatibility in its level implementation. The inconvenience of disequilibrium and the reinstatement of equilibrium can be studied with the help of this analysis.

It helps in understanding the compound problems existing in the market. Presume the demand for the product 'A' goes up which may escort to a increase in its price. This in turn diminishes the prices of its surrogates and elevates the prices of balance. These may lessen the demand for 'A' to some extent. Thus general equilibrium analysis assists in understanding the nature of complex chains of interactions of the market on a gradual basis.

It facilitates in knowing the work of a pricing course, as to fix on how much and what to produce. It also helps in learning the input-output analysis. The general equilibrium analysis has been comprehensive to fiscal theory and benefit economic in that way assembling them more pragmatic fields of economic learning.

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