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A General Equilibrium Of All Markets
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Having stated the fundamental proposition about competitive markets, we will explore the reasons behind this remarkable result. Let's review the behavior of individual markets first:
â€¢ Competitive supply and demand operate to determine prices and quantities in individual markets.
â€¢ Market demand curves are derived from the marginal utilities of different goods.
â€¢ The marginal costs of different commodities lie behind their competitive supply curves.
â€¢ Firms calculate marginal costs of products and marginal revenue products of factors IWC Replica and then choose inputs and outputs so as to maximize profits.
â€¢ These marginal revenue products, summed for all firms, provide the derived demands for the factors of production.
â€¢ These derived demands for land, labor, or capital goods interact with their market supplies to determine factor prices such as rent, wages, and interest rates.
â€¢ The factor prices and quantities determine incomes, which then close the circle back to Steps 1 and 2 by helping to determine the demand for different commodities.
All these statements are the result of partial equilibrium analysis, which involves the behavior of a single market, household, or firm, taking the behavior of all other markets and the rest of the economy as given. In this unit, we are concerned with general-equilibrium analysis, which examines how (and how successfully) all the households, firms, and markets interact simultaneously to solve the questions of how, what, and for whom.It is the interconnectedness of economic life that makes it so intricate and complex. How was it that a revolution in Iran in 1979 led to a worldwide oil price increase, lowering the demand for automobiles and causing thousands of steelworkers to lose their jobs? How did the reunification of Germany in 1990 lead to higher interest rates in Germany, thereby producing stagnation in the rest of Europe, and then to a currency crisis and a breakdown of the European Monetary System? These and countless other economic impacts take place through the general equilibrium interactions of the seven steps outlined above.
Notice how our list of steps follows a logical progression from step to step. But in real life, which comes first? Is there an orderly sequence that determines prices in single markets on Monday, evaluates consumer preferences on Tuesday, and reckons business costs on Wednesday and marginal products on Thursday? Obviously not. All these Omega Replica partial-equilibrium processes are going on simultaneously.
That is not all. These different activities do not go on independently, each in its own little groove, careful not to get in the way of the others. All the processes of supply and demand, of cost and preference, of factor productivity and demand are really different aspects of one vast, simultaneous, interdependent process.
Thus we see a logical structure behind the millions of markets determining prices and outputs: (1) Households, which want to maximize their satisfactions, supply factors and buy products while (2) firms, guided by the lure of profits, transform factors bought from households into products sold to households. The logical structure of a general equilibrium system is complete.
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