The Economics Book

122 ECONOMIC EQUILIBRIUM

An auctioneer takes bids at a
cattle auction. Walras imagined an
auctioneer who provides perfect
information for the market. He
announces prices, and a sale only
takes place at the point of equilibrium.

The equilibrium...

reestablishes itself

automatically as soon

as it is disturbed.

Léon Walras

and demand are perfectly balanced
with no shortages or surpluses.
Walras went on to apply the idea of
equilibrium to the whole economy
in order to create a theory of
general equilibrium. This was
based on the assumption that
when goods are in surplus in one
area, the price must be too high.
Prices are judged “too high” by
comparison, so if one market’s
prices are “too high,” there must be
another where prices are “too low,”
causing a surplus in the higher-
priced market.
Walras created a mathematical
model for the whole economy,
including goods such as chairs and
wheat and factors of production
such as capital and labor.
Everything was interlinked and
dependent on everything else. He
insisted that interdependency is
key; price changes do not take
place in a vacuum—they only
occur because of a change in
supply or demand. Moreover,
when prices change, everything

else also changes. One small

change in one part of the economy

can ripple through the entire

economy. For example, suppose

that a war breaks out in a major

oil-producing country. Prices of oil

across the world will rise, which

will have far-reaching effects on

governments, firms, and

individuals—from increased prices

at gas stations and increased

heating costs at home, to being

forced to cancel a now-expensive

vacation or business trip.

Toward equilibrium

Walras succeeded in reducing

his mathematical model of an

economy to a few equations

containing prices and quantities.

He drew two conclusions from

his work. The first was that a

state of general equilibrium is

theoretically possible. The second

was that wherever an economy

started, a free market could move

it toward general equilibrium. So

a system of free markets could be

inherently stable.

Walras showed how this

might happen through an idea

he called tâtonnement (groping),

in which an economy “gropes” its

way up to an equilibrium just as

a climber gropes his way up a

mountain. He thought about

this by imagining a theoretical

“auctioneer” to whom buyers

and sellers submit information

about how much they would buy

or sell goods at different prices.

The auctioneer then announces

the prices at which supply equals

demand in every market, and only

then does buying and selling begin.

Flaws in the model

Walras was quick to point out that

this was simply a mathematical

model, designed to help

economists. It was not intended

to be taken to be a description

of the real world. His work was

largely ignored by his

contemporaries, many of whom

believed that real-world interactions

are too complex and chaotic for a

true state of equilibrium to develop.

On a technical level Walras’s

complex equations were too

difficult for many economists to

master, which was another reason

why he was ignored, although his

student Vilfredo Pareto (p.131)

later developed his work in new

directions. In the 1930s, two