Partial equilibrium
Encyclopedia
Partial equilibrium is a condition of economic equilibrium
which takes into consideration only a part of the market, ceteris paribus
, to attain equilibrium.
As defined by George Stigler
, "A partial equilibrium is one which is based on only a restricted range of data, a standard example is price of a single product, the prices of all other products being held fixed during the analysis."
The Supply and demand model
is a partial equilibrium model where the clearance on the market
of some specific goods is obtained independently from prices and quantities in other markets. In other words, the prices of all substitutes
and complements
, as well as income
levels of consumers
are constant. This makes analysis much simpler than in a general equilibrium
model which includes an entire economy.
Here the dynamic process is that prices adjust until supply equals demand. It is a powerfully simple technique that allows one to study equilibrium
, efficiency
and comparative statics
. The stringency of the simplifying assumptions inherent in this approach make the model considerably more tractable, but may produce results which, while seemingly precise, do not effectively model real world economic
phenomena.
Partial equilibrium analysis examines the effects of policy action in creating equilibrium only in that particular sector or market which is directly affected, ignoring its effect in any other market or industry assuming that they being small will have little impact if any.
Hence this analysis is considered to be useful in constricted markets.
Léon Walras
first formalized the idea of a one-period economic equilibrium of the general economic system, but it was French economist Antoine Augustin Cournot
and English political economist Alfred Marshall
who developed tractable models to analyze an economic system.
2. Consumer’s taste and preferences, habits, incomes are also considered to be constant.
3. Prices of prolific resources of a commodity and that of other related goods (substitute or complimentary) are known as well as
constant.
4. Industry is easily availed with factors of production at a known and constant price compliant with the methods of production in use.
5. Prices of the products that the factor of production helps in producing and the price and quantity of other factors are known and constant.
6. There is perfect mobility of factors of production between occupation and places.
The above mentioned points relate to a perfectly competitive market but can be further extended to monopolistic competition
, oligopoly
, monopoly
and monopsony
markets.
, a industry
, factors of production attain their equilibrium points-
1. A consumer is in a state of equilibrium when he achieves maximum aggregate satisfaction on the expenditure that he makes depending on the set of conditions relating to his tastes and preferences, income, price and supply of the commodity etc.
2. Producers’ equilibrium occurs when he maximizes his net profit subject to a given set of economic situations.
3. A firm’s equilibrium point is when it has no inclination in changing its production.
In short run Marginal revenue
= Marginal Cost
and in long run LMC=MR=AR=LAC at its minimum are the conditions of equilibrium.
NOTE-
It means that a firm is earning only a ‘normal profit’ and has no intension to leave the industry
.
4. Equilibrium for an industry happens when there is normal profit made by an industry It is such a situation when no new firm wants to enter into it and the existing firm does not want to exit.
Only one price prevails in the market for a single product where the quantity of goods purchased by a buyer = total quantity produced by different firms.
All the firms produces till that level where Marginal Cost
=Marginal revenue
, and sells the product at market price ruling at that point of time.
5. Factors of production, i.e. land, labor, capital and entrepreneurs are in equilibrium when they are paid the maximum possible so as maximize the income. Here the Price
= Marginal Revenue Product.
At this price it does not have any enticement to look for employment
anywhere else.
The quantity of factors which its owners want to sell should be = the quantity which the entrepreneurs are ready to hire.
, a firm
or an industry
. It does not take into account the study of economics
.
2. It lacks the ability to study the interrelations of all the parts of the economy
.
3. This analysis will fail if the improbable assumptions, which disconnect the study of specific market
from the rest of the economy
, are not taken into consideration.
4. It has been unsuccessful in explaining the outcome of economic disturbance in the market that leads to demand
and supply
changes, moving from one market to another and thus instigating second, third order waves of change in the whole economy
.
In the graph given here, P1 is the price that a consumer is ready to pay for a particular product. But the producer may reduce the price to P2 expecting that either more people would buy at the reduced rate, or the person who was ready to pay P1 will purchase more of the same. The producer may further reduce the price to P3, again expecting more buyers or the same buyers purchasing more.
The price keeps on falling until P’, where the demand and the supply curve intersect: their intersection is the equilibrium point. Hence the consumer surplus for first consumer can be calculated as P1 - P’, decreasing for the second consumer to P1 - P’, and so on. Thus the total consumer surplus in the market can be obtained by summing up the three rectangles. The purple colored triangle indicates that area.
If only one unit of the commodity was demanded at the price P1, this becomes the price which the producer expects to receive. But if two units are demanded, the minimum price at which the producer would be ready to increase the supply
shifts to P2. This continues and the final price that ultimately prevails in the market is P’, the price which is obtained by the intersection of the demand
and supply
curve in the market. The producer’s surplus here would be initial price minus the final price. And total consumer surplus in the market will be summation of the three rectangles.
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
which takes into consideration only a part of the market, ceteris paribus
Ceteris paribus
or is a Latin phrase, literally translated as "with other things the same," or "all other things being equal or held constant." It is an example of an ablative absolute and is commonly rendered in English as "all other things being equal." A prediction, or a statement about causal or logical...
, to attain equilibrium.
As defined by George Stigler
George Stigler
George Joseph Stigler was a U.S. economist. He won the Nobel Memorial Prize in Economic Sciences in 1982, and was a key leader of the Chicago School of Economics, along with his close friend Milton Friedman....
, "A partial equilibrium is one which is based on only a restricted range of data, a standard example is price of a single product, the prices of all other products being held fixed during the analysis."
The Supply and demand model
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
is a partial equilibrium model where the clearance on the market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
of some specific goods is obtained independently from prices and quantities in other markets. In other words, the prices of all substitutes
Substitute good
In economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...
and complements
Complement good
A complementary good, in contrast to a substitute good, is a good with a negative cross elasticity of demand. This means a good's demand is increased when the price of another good is decreased. Conversely, the demand for a good is decreased when the price of another good is increased...
, as well as income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
levels of consumers
Consumer
Consumer is a broad label for any individuals or households that use goods generated within the economy. The concept of a consumer occurs in different contexts, so that the usage and significance of the term may vary.-Economics and marketing:...
are constant. This makes analysis much simpler than in a general equilibrium
General equilibrium
General equilibrium theory is a branch of theoretical economics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many interacting markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium, hence general...
model which includes an entire economy.
Here the dynamic process is that prices adjust until supply equals demand. It is a powerfully simple technique that allows one to study equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
, efficiency
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
and comparative statics
Comparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....
. The stringency of the simplifying assumptions inherent in this approach make the model considerably more tractable, but may produce results which, while seemingly precise, do not effectively model real world economic
phenomena.
Partial equilibrium analysis examines the effects of policy action in creating equilibrium only in that particular sector or market which is directly affected, ignoring its effect in any other market or industry assuming that they being small will have little impact if any.
Hence this analysis is considered to be useful in constricted markets.
Léon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...
first formalized the idea of a one-period economic equilibrium of the general economic system, but it was French economist Antoine Augustin Cournot
Antoine Augustin Cournot
Antoine Augustin Cournot was a French philosopher and mathematician.Antoine Augustin Cournot was born at Gray, Haute-Saone. In 1821 he entered one of the most prestigious Grande École, the École Normale Supérieure, and in 1829 he had earned a doctoral degree in mathematics, with mechanics as his...
and English political economist Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...
who developed tractable models to analyze an economic system.
Assumptions
1. Commodity price is given and constant for the consumers.2. Consumer’s taste and preferences, habits, incomes are also considered to be constant.
3. Prices of prolific resources of a commodity and that of other related goods (substitute or complimentary) are known as well as
constant.
4. Industry is easily availed with factors of production at a known and constant price compliant with the methods of production in use.
5. Prices of the products that the factor of production helps in producing and the price and quantity of other factors are known and constant.
6. There is perfect mobility of factors of production between occupation and places.
The above mentioned points relate to a perfectly competitive market but can be further extended to monopolistic competition
Monopolistic competition
Monopolistic competition is imperfect competition where many competing producers sell products that are differentiated from one another...
, oligopoly
Oligopoly
An oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek ὀλίγοι "few" + πόλειν "to sell". Because there are few sellers, each oligopolist is likely to be aware of the actions of the others...
, monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
and monopsony
Monopsony
In economics, a monopsony is a market form in which only one buyer faces many sellers. It is an example of imperfect competition, similar to a monopoly, in which only one seller faces many buyers...
markets.
Applications
Applications of partial equilibrium discusses, when does an individual, a firmFirm
A firm is a business.Firm or The Firm may also refer to:-Organizations:* Hooligan firm, a group of unruly football fans* The Firm, Inc., a talent management company* Fair Immigration Reform Movement...
, a industry
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
, factors of production attain their equilibrium points-
1. A consumer is in a state of equilibrium when he achieves maximum aggregate satisfaction on the expenditure that he makes depending on the set of conditions relating to his tastes and preferences, income, price and supply of the commodity etc.
2. Producers’ equilibrium occurs when he maximizes his net profit subject to a given set of economic situations.
3. A firm’s equilibrium point is when it has no inclination in changing its production.
In short run Marginal revenue
Marginal revenue
In microeconomics, marginal revenue is the extra revenue that an additional unit of product will bring. It is the additional income from selling one more unit of a good; sometimes equal to price...
= Marginal Cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
and in long run LMC=MR=AR=LAC at its minimum are the conditions of equilibrium.
NOTE-
| Abbreviation | Full Form |
|---|---|
| LMC | Long run marginal cost |
| MR | Marginal revenue Marginal revenue In microeconomics, marginal revenue is the extra revenue that an additional unit of product will bring. It is the additional income from selling one more unit of a good; sometimes equal to price... |
| MC | Marginal cost Marginal cost In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good... |
| LAC | Long run average cost |
It means that a firm is earning only a ‘normal profit’ and has no intension to leave the industry
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
.
4. Equilibrium for an industry happens when there is normal profit made by an industry It is such a situation when no new firm wants to enter into it and the existing firm does not want to exit.
Only one price prevails in the market for a single product where the quantity of goods purchased by a buyer = total quantity produced by different firms.
All the firms produces till that level where Marginal Cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
=Marginal revenue
Marginal revenue
In microeconomics, marginal revenue is the extra revenue that an additional unit of product will bring. It is the additional income from selling one more unit of a good; sometimes equal to price...
, and sells the product at market price ruling at that point of time.
5. Factors of production, i.e. land, labor, capital and entrepreneurs are in equilibrium when they are paid the maximum possible so as maximize the income. Here the Price
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
= Marginal Revenue Product.
At this price it does not have any enticement to look for employment
Employment
Employment is a contract between two parties, one being the employer and the other being the employee. An employee may be defined as:- Employee :...
anywhere else.
The quantity of factors which its owners want to sell should be = the quantity which the entrepreneurs are ready to hire.
Limitations
1. It is restricted to one particular field. Be it a case of an individualIndividual
An individual is a person or any specific object or thing in a collection. Individuality is the state or quality of being an individual; a person separate from other persons and possessing his or her own needs, goals, and desires. Being self expressive...
, a firm
Firm
A firm is a business.Firm or The Firm may also refer to:-Organizations:* Hooligan firm, a group of unruly football fans* The Firm, Inc., a talent management company* Fair Immigration Reform Movement...
or an industry
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
. It does not take into account the study of economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
.
2. It lacks the ability to study the interrelations of all the parts of the economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
.
3. This analysis will fail if the improbable assumptions, which disconnect the study of specific market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
from the rest of the economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
, are not taken into consideration.
4. It has been unsuccessful in explaining the outcome of economic disturbance in the market that leads to demand
Demand
- Economics :*Demand , the desire to own something and the ability to pay for it*Demand curve, a graphic representation of a demand schedule*Demand deposit, the money in checking accounts...
and supply
Supply
*Supply , the amount of a product which is available to customers*Supply, as in confidence and supply, the provision of funds for government expenditure...
changes, moving from one market to another and thus instigating second, third order waves of change in the whole economy
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
.
Welfare Effect of Trade Policies
In partial equilibrium the welfare effects on consumers who purchase and the producers who produce in the market is distinguished by consumer surplus and producer surplus.Consumer surplus
The amount that a consumer is ready to pay for a particular good minus the amount that the consumer actually pays. The amount that the consumer is willing to pay has to be greater.In the graph given here, P1 is the price that a consumer is ready to pay for a particular product. But the producer may reduce the price to P2 expecting that either more people would buy at the reduced rate, or the person who was ready to pay P1 will purchase more of the same. The producer may further reduce the price to P3, again expecting more buyers or the same buyers purchasing more.
The price keeps on falling until P’, where the demand and the supply curve intersect: their intersection is the equilibrium point. Hence the consumer surplus for first consumer can be calculated as P1 - P’, decreasing for the second consumer to P1 - P’, and so on. Thus the total consumer surplus in the market can be obtained by summing up the three rectangles. The purple colored triangle indicates that area.
Producer surplus
Amount that a producer finally receives by selling a particular product minus the amount the producer is ready to accept for that good. The amount that the producer receives should be greater.If only one unit of the commodity was demanded at the price P1, this becomes the price which the producer expects to receive. But if two units are demanded, the minimum price at which the producer would be ready to increase the supply
Supply
*Supply , the amount of a product which is available to customers*Supply, as in confidence and supply, the provision of funds for government expenditure...
shifts to P2. This continues and the final price that ultimately prevails in the market is P’, the price which is obtained by the intersection of the demand
Demand
- Economics :*Demand , the desire to own something and the ability to pay for it*Demand curve, a graphic representation of a demand schedule*Demand deposit, the money in checking accounts...
and supply
Supply
*Supply , the amount of a product which is available to customers*Supply, as in confidence and supply, the provision of funds for government expenditure...
curve in the market. The producer’s surplus here would be initial price minus the final price. And total consumer surplus in the market will be summation of the three rectangles.
Difference between Partial and General Equilibrium
| Partial Equilibrium | General Equilibrium |
|---|---|
| • Developed by Alfred Marshall Alfred Marshall Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years... . |
• Leon Walras Léon Walras Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:... was first to develop it. |
| • Related to single variable | • More than one variable or economy as a whole is taken into consideration |
| • Based on two assumptions- 1. Ceteris Paribus Ceteris paribus or is a Latin phrase, literally translated as "with other things the same," or "all other things being equal or held constant." It is an example of an ablative absolute and is commonly rendered in English as "all other things being equal." A prediction, or a statement about causal or logical... 2. Other sectors are not affected due to change in one sector. |
• It is based on the assumption that various sectors are mutually interdependent. There is an effect on other sectors due to change in one. |
| • Other things remaining constant, price of a good is determined | •Prices of goods are determined simultaneously and mutually. Hence all product and factor markets are simultaneously in equilibrium. |