121
general equilibrium theory was
devised to explain the production,
consumption, and prices across
an entire economy.
Supply and demand
Walras began by focusing on how
exchanges worked—how the prices
of goods, the quantity of goods,
and the demand for goods interact.
In other words he was trying to
pin down just how supply and
demand tally. He believed that the
value of something for sale depends
essentially on its rareté—which
means “rarity,” but was used
by Walras to express just how
intensely something is needed.
In this respect Walras differed
from many of his contemporaries,
including Edgeworth and William
Stanley Jevons (p.115), who
believed that utility—either as
pleasure or usefulness—is the
key to value.
Walras began to construct
mathematical models to describe
the relationship between supply
and demand. These revealed that
as price escalates, demand falls
and supply climbs. Where demand
and supply match, the market is
in a state of equilibrium, or
balance. This reflected the same
kind of simple balancing forces
that were evident in Newton’s
laws of motion.
General equilibrium
To illustrate this equilibrium,
imagine that today the current
market price of mobile phones is
$20. In a local market store owners
have 100 phones for which they
want $20. If 100 buyers visit the
market, each willing to pay $20,
the market for cheap mobiles is in
equilibrium because the supply ❯❯
See also: The circular flow of the economy 40–45 ■ Free market economics 54–61 ■ Supply and demand 108–13 ■
Efficiency and fairness 130–31 ■ Markets and social outcomes 210–13 ■ Complexity and chaos 278–79
INDUSTRIAL AND ECONOMIC REVOLUTIONS
Where there are shortages,
prices rise.Shortages of supply in
one area of the economy
create surpluses of
supply elsewhere.A system
of free markets
is stable.Where there are surpluses,
prices fall.As prices fall, demand
rises and supply falls,
eliminating surplus.As prices rise, demand
falls and supply rises,
eliminating shortages.Economies as a whole
tend toward equilibrium
as long as they are free
to do so.