Importance of General Equilibrium Theory

Importance of General Equilibrium Theory:

Despite its limitations, the general equilibrium theory (as represented in Walras’ model) has its uses. This theory, it is pointed out, is the strongest argument for a capitalist system. Walras’ model represents a capitalistic system in equilibrium. All the consumers and producers are supposed to have made their best adjustments in this system. Production in such a system is both efficient as well as responsive to the wants of the consumers. The consumer’s satisfaction is also maximized. Besides, the system ensures maximum economic welfare. The term “economic welfare” is interpreted here to mean “economic efficiency”. In Walras’ model, maximum efficiency is achieved. No resources are wasted. “There cannot be more production of any one good without less production of another, and one household cannot consume more unless another consumes less.”

Though the general equilibrium model achieves efficiency, it fails to secure equity in the distribution of national income. There is nothing in Walras’ model which prevents some households from cornering a major portion of the national income for their own benefit. It leads, therefore, to unjust and inequitable distribution of national wealth. Besides, the entrepreneurs in Walra’s model are social parasites. They fulfill no social responsibilities. Their effort is merely to maximize their own profits at the expense of the community. This they do in two ways:

  • By cutting down their costs to a minimum.
  • By maximizing the prices.

Further, the entrepreneurs are not the real entrepreneurs in Walras’ model, in so far as they are neither innovators nor risk-takers.

The greatest use of the general equilibrium theory is that it has provided the basis for the input-output analysis, which has been developed by Prof. Wassily Leontief, a mathematical economist at Harvard University. He has devised an ingenious Table for showing the balanced relationships in the economy as a whole. This is known as Input-Output Table. Such a Table shows the inputs and outputs of the major branches of the national economy of a country. The Input-Output Table is the statistical measurement of the inputs and outputs of all the industries taken together in the economy. It brings out the interdependent nature of the national economy, how the output of one industry forms the input of another. For example, the output of the steel industry (i.e., steel) constitutes the input of so many industries like locomotive and wagon industries or machine-making industries. In the Input-Output Table, we have a precise picture of the input-output relationships of the entire economic process.

Assuming general equilibrium, each branch of the national economy would produce just what was required of its products by all other branches, so that there would neither be under-production nor overproduction in the economy. We, however, know that no such perfect balance between demand and supply is maintained in actual feet. There are always some maladjustments between demand and supply in the actual working of the economy, though the pricing subsystem tries to minimize these maladjustment in its own way.

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