General equilibrium theory

In economics, general equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an overall general equilibrium. General equilibrium theory contrasts to the theory of partial equilibrium, which only analyzes single markets.

General equilibrium theory both studies economies using the model of equilibrium pricing and seeks to determine in which circumstances the assumptions of general equilibrium will hold. The theory dates to the 1870s, particularly the work of French economist Léon Walras in his pioneering 1874 work Elements of Pure Economics.

It is often assumed that agents are price takers, and under that assumption two common notions of equilibrium exist: Walrasian, or competitive equilibrium, and its generalization: a price equilibrium with transfers.

Broadly speaking, general equilibrium tries to give an understanding of the whole economy using a "bottom-up" approach, starting with individual markets and agents. (Macroeconomics, as developed by the Keynesian economists, focused on a "top-down" approach, where the analysis starts with larger aggregates, the "big picture".) Therefore, general equilibrium theory has traditionally been classified as part of microeconomics.

The difference is not as clear as it used to be, since much of modern macroeconomics has emphasized microeconomic foundations, and has constructed . General equilibrium macroeconomic models usually have a simplified structure that only incorporates a few markets, like a "goods market" and a "financial market". In contrast, general equilibrium models in the microeconomic tradition typically involve a multitude of different goods markets. They are usually complex and require computers to help with numerical solutions.

In a market system the prices and production of all goods, including the price of money and interest, are interrelated. A change in the price of one good, say bread, may affect another price, such as bakers' wages. If bakers don't differ in tastes from others, the demand for bread might be affected by a change in bakers' wages, with a consequent effect on the price of bread. Calculating the equilibrium price of just one good, in theory, requires an analysis that accounts for all of the millions of different goods that are available.

...
Wikipedia