“General equilibrium is the statement that all the different parts of the economy influence each other, even if it’s remote, like mortgage-backed securities and their demands on automobiles.” — Kenneth Arrow
Economists rediscover Indra’s jewel net.
During my graduate school days at Berkeley, I once asked my advisor how she would characterize me. She replied, “You’re an old-world liberal. A classical liberal.” It took me several years to fully understand what she meant and how accurate her assessment was.
The dharmas (Sanatan dharma, Buddha dharma, and Jain dharma) have the concept of reincarnation. Some elements of a particular consciousness get transmitted from one life to another and are reborn in another particular consciousness. It’s possible. And there’s quite a lot of evidence that it could be true.
When I began learning about classical liberal ideas, it was as if I already knew them implicitly but was now merely learning the associated vocabulary. I conjecture that I am in some sense a reincarnated classical liberal.
My advisor was a tough woman. She had served her time in the Israeli army before getting her economics PhD. She was an expert on computable general equilibrium models. (See the notes to this post for a description of CGE models) I looked into them for a few months and concluded that they did not interest me. I was more of a price theory person, not into general equilibrium.
That said, GE is a fascinating concept that is (at least to some) intuitive. It was to me. I could see why it made sense. Every well-educated person should know what it is. Fortunately, these days knowing the basics of any topic is trivial: you ask an AI agent. But of course, you have to know what to ask. Education is what you need to be able to use AI agents.
General equilibrium (GE) models analyze how multiple markets interact simultaneously to determine prices, quantities, and allocations across an entire economy.
In the notes to this post, I list some of the important and influential GE models, based on their widespread use in theory and policy. I’ve focused on the classics and key modern variants, with brief descriptions of their core features and significance. (Disclosure: Written with a little help from my friend Grok.)
I also asked Grok for quotes related to GE. I used one of the quotes as an epigraph to this post.
“While economic theory in general may be defined as the theory of how an economic condition or an economic development is determined within an institutional framework, the welfare theory deals with how to judge whether one condition can be said to be better in some way than another and whether it is possible, by altering the institutional framework, to achieve a better condition than the present one.”— Kenneth Arrow
“The general theory of economic equilibrium was strengthened and made effective as an organon of thought by two powerful subsidiary conceptions — the Margin and Substitution.”— John Maynard Keynes
“We know, in other words, the general conditions in which what we call, somewhat misleadingly, an equilibrium will establish itself: but we never know what the particular prices or wages are which would exist if the market were to bring about such an equilibrium.”— Friedrich August von Hayek
“Nothing has done more to render modern economic theory a sterile and irrelevant exercise in autoeroticism than its practitioners’ obsession with mathematical, general-equilibrium models.”— Robert Locke
“Economists are good (or so we hope) at recognizing a state of equilibrium but are poor at predicting precisely how an economy in disequilibrium will evolve.”— Andreu Mas-Colell, Michael D. Whinston, and Jerry R. Green
I like Robert Locke’s delicate phrasing: “a sterile and irrelevant exercise in autoeroticism.”
The last quote above is by MWG, the authors of a grad-level micro econ textbook. That book is the stuff that nightmares are made of. (I mentioned that book in an Oct 2020 post. I also mention fixed point theorems in that post. The MWG book is available from the Oxford University Press for the low, low price of $159 plus tax and shipping.)
This post was about general equilibrium. It still is. But I somehow digressed into reincarnation. So let’s listen to a favorite song that is about reincarnation, shall we? Al Stewart begins his “One Stage Before” with —
It seems to me as though I’ve been upon this stage before
And juggled away the night for the same old crowd
These harlequins you see with me, they too have held the floor
As here once again they strut and they fret their hour . . .
Strut and fret their hour! Nicely done, Mr Stewart, very nicely done. No doubt taken from Macbeth’s soliloquy, “. . . A poor player that struts and frets his hour upon the stage . . .”
That’s it for now. Below is the promised intro to general equilibrium theories. Enjoy.
Image at the top of the post credit Indra’s Jewel Net. Indra’s net is an illustration of a GE model.
NOTES on General Equilibrium models
- Walrasian Equilibrium Model
Developed by Léon Walras in the late 19th century, this is the foundational static GE model. It assumes competitive markets where prices adjust via a hypothetical “tâtonnement” (groping) process until supply equals demand in all markets simultaneously, achieving equilibrium. Key features include price-taking agents, no production in basic versions (later extended), and Pareto efficiency under certain conditions. Its importance lies in establishing the concept of interdependence across markets, influencing microeconomic theory and proofs of equilibrium existence. It’s widely used to study resource allocation, tax incidence, and policy impacts in areas like trade and public finance.
- Arrow-Debreu Model
Formalized by Kenneth Arrow and Gérard Debreu in the 1950s, this axiomatic extension of the Walrasian model incorporates uncertainty, time, and space through “contingent commodities” (e.g., goods delivered at specific times, locations, or states of nature). It assumes complete markets, convex preferences and technologies, and proves the existence and efficiency of competitive equilibria using fixed-point theorems. Significance: It provides a rigorous mathematical foundation for GE theory, enabling analysis of intertemporal allocation, risk-sharing, and welfare theorems. This model underpins much of modern finance and macroeconomics, though it’s criticized for unrealistic assumptions like perfect foresight.
- Overlapping Generations (OLG) Model
Introduced by Paul Samuelson in 1958 (building on earlier work by Maurice Allais and Irving Fisher), and extended by Peter Diamond in 1965 to include production. In this dynamic GE framework, agents live finite lives (typically two periods: young and old), overlapping across generations, with decisions on saving, consumption, and work affecting intergenerational resource transfers. Key features include potential for multiple equilibria, dynamic inefficiency (e.g., over-saving), and no infinite horizons. Its importance is in modeling life-cycle behavior, demographic transitions, Social Security, and economic growth; it explains phenomena like money as a store of value and challenges the Pareto efficiency of equilibria in infinite-agent settings. OLG models are crucial for studying fertility, human capital, and long-run dynamics absent in static models.
- Computable General Equilibrium (CGE) Models
Evolving from Walrasian and Arrow-Debreu foundations, CGE models were pioneered in the 1960s-1970s. These are numerical, data-driven simulations that calibrate economic theory to real-world data (e.g., via Social Accounting Matrices) to compute equilibria under policy shocks. Features include sector interdependencies, elasticities for substitution, and flexibility for taxes, trade, or externalities; they can be static or dynamic. Significance: Used by governments, international organizations (e.g., World Bank, IMF), and academics for policy analysis, such as fiscal reforms, trade agreements, or climate impacts. CGE bridges theory and empirics, revealing indirect effects that partial equilibrium misses.
- Dynamic Stochastic General Equilibrium (DSGE) Models
Developed in the 1980s-1990s, building on real business cycle theory and incorporating elements like sticky prices. DSGE integrates microfoundations with stochastic shocks (e.g., technology or demand) in a dynamic GE setting, often with infinite-lived agents optimizing under rational expectations. Variants include New Classical (frictionless markets) and New Keynesian (with rigidities like wage stickiness). Importance: Dominant in modern macroeconomics for forecasting, monetary policy (used by central banks like the Fed), and analyzing business cycles. It micro-founds aggregate behavior, allowing simulations of shocks, but faces criticism for oversimplifying real-world frictions post-2008 crisis.
These models form the backbone of GE theory, evolving from abstract static frameworks to practical tools for policy.
Atanu Dey : Life is a Random Draw 