Equilibrium models form a very powerful set of tools for the analysis of how markets come into balance within economics.
The basic characteristic of equilibrium as an economic condition is that demand equals supply, coupled with the absence of some inherent pressure for change.
Equilibrium models are very widely used by economists when analyzing the functioning of markets, industries, and whole economies.
Thereby, their main purpose is to answer how such markets, industries, or even the economy changes in response to a new policy, technological progress, or a change in consumer preferences.
From all approaches implemented using this kind of analysis, two are particularly crucial: general and partial equilibrium models.
This article discusses those differences in detail.
What is Partial Equilibrium?
Partial Equilibrium Model is an approach taken in the analysis of equilibrium condition within one market or sector, in isolation from others.
In this way it supposes that other markets may stay constant or will not change if the market being studied changes.
This model allows the economists to know and analyze the supply-demand dynamics happening in a single market, say, bread, oil, or labor, without having to think about the entire economy.
Critical Characteristics of Partial Equilibrium Models
1. Isolation of Markets
A partial equilibrium model could only analyze one market while assuming the prices, demand, and supply in all the other markets to be unchanged.
This assumption simplification will help ease the study as this can easily analyze the effects of specific variables on the single market.
2. Ceteris Paribus Assumption
Partial equilibrium models rely on the ceteris paribus assumption or “all things other being equal.” This enables economists to separate pure effects of some particular change in one market without worrying over the complex interdependencies with other markets.
3. Policy Analysis
Partial Equilibrium Models are largely used in policy analyses. They are applicable to scrutinize the effects of taxes, subsidies, or price control on one market.
A government uses partial equilibrium models when it wants to know how the imposition of a tax on cigarette smoking would affect the price and quantity of cigarettes sold.
It is very narrow in scope because it does not consider spillover effects on other markets.
4. Simplified Analysis
Since it adopts an isolated approach, partial equilibrium analysis is relatively less complex and requires fewer data than the general equilibrium model.
Such simplicity makes the partial equilibrium analysis very useful in short-term analyses or when information is extremely limited.
Limitations of Partial Equilibrium Models
Despite its simpleness, partial equilibrium models are also bound by certain limitations:
Interdependencies
Partial equilibrium models focus on one single market while ignoring the interdependence and dependence issues between markets.
for example, if the government increase the tax on gasoline, this action will have implications or might influence another market, say transportation or food. Partial equilibrium tends to ignore such implications.
Not Applicable for Big Changes: General equilibrium models cannot be used to analyze large-scale policy changes or economic shocks that simultaneously influence several markets.
They are best for small, relatively insulated changes but fail to capture the broader impacts of larger policies.
What is General Equilibrium?
In general, a general equilibrium model looks at conditions for simultaneous equilibrium in all markets in the economy.
This therefore considers how any shift within one market affects others and captures the complicated nature of economic systems.
Generally, then, the general equilibrium model will find a set of prices and quantities of all goods and services that exist within an economy such that in every market, the amounts supplied equal the amounts demanded.
Important features of general equilibrium models
1. Interlinkages between Markets
General equilibrium models take into account interlinkages between quite a few markets and the consequences for the whole economy of changes in one market, since such change is transmitted through ripples throughout the economy when those effects begin to materialize in several other markets also.
Thus, for example, if demand for cars rises, it can increase demand for steel, labor, and fuel and has ripple effects on the mentioned markets also.
2. Economy perspective
General equilibrium models tend to view the economy as a whole wherein interaction of markets with each other is analyzed. It is useful to understand how economic policies, technological changes, or external shocks would affect the whole economy.
3. Complete Set of Markets Assumption
It is assumed that general equilibrium models make up a complete set of markets, meaning for every good and service, there exists its market with associated price. At this assumption, the model can discover conditions under equilibrium potential in each and every one of them.
4. Use of General Equilibrium Models
in Complex Policy Analysis: In complex policy analysis, general equilibrium models are mostly used to analyze, for example, the effects of trade policies, tax reforms, or environmental regulations on the economy.
A government can make use of the model to calculate the various impacts of a carbon tax: on the energy sector itself and on other areas like manufacturing, transportation, and consumer spending.
Types of General Equilibrium Models
There are several categories of general equilibrium models with their assumptions and applications:
Static General Equilibrium Models
The model pins consideration to a point in time and gives a snapshot view of how all markets simultaneously reach equilibrium.
Dynamic General Equilibrium Models
They do include time, moving through the development of the economy through several periods. Dynamic models are useful in the analysis of long-term economic growth and structural changes.
Computable General Equilibrium Models
CGE models are based on real data and rely on computation methods to try to find the way in which an economy would respond to different policies or shocks. Such models are predominantly utilized by the government and international organizations, especially concerning policy analysis as well as forecasting.
Limitations of General Equilibrium Models
General equilibrium models provide a general perspective, though they do carry some limitations.
Data Requirements and Complexity
General equilibrium models are typically very data-intensive. Not only are they complex to design, but an enormous amount of information regarding preference functions, production technologies, and inter-market relationships must be known to construct them.
Too much reliance on rigorous assumptions
General equilibrium models rely on so many unrealistic assumptions, such as perfect competition and complete market assumptions associated with rational behavior, which rarely occurs in practice.
Such assumptions create some imperfection in the model, which fails to provide correct results for some cases.
Weak representation of market failures
General equilibrium models are weak in representing market failures, such as externalities and monopolies.
Differences between General Equiilibrium and Partial Equilibrium
|
Features |
General Equilibrium |
Partial Equilibrium |
|
Scope |
Studies all the markets together |
Concentrates on one particular market |
|
Interdependencies |
Takes into consideration inter-market interdependencies |
Non-interactions between markets are ignored |
|
Data Requirements |
High because it depends on detailed data of an economy |
Low; a market in question is adequate in terms of data requirements |
|
Complexity |
High: often computational in nature |
Low: easier to construct and analyze |
|
Application of Policy |
Use appropriate to complex, economy-wide policies |
Use in analyzing isolated policies |
|
Assumptions |
Assumes markets are complete and that there exists perfect competition |
Uses the ceteris paribus, “all else equal” |
When to Apply Each Model?
The general equilibrium model or partial equilibrium models depend on the scope and objectives of the analysis:
• Partial equilibrium models can be useful in describing changes in policy or shifts in demand and supply within a particular market. It is very helpful especially when other markets may be affected minimally or when simplification is needed.
• General Equilibrium Models would be the best tool to show the widespread effects of large policies affecting many markets, as is the case for general tax reform, trade policies, or significant structural economic shocks. They describe the economy in its more holistic view but require the highest input of data and resources to simulate and work out.
Conclusion
There are two rudimentary frameworks of analysis available, which are general equilibrium and partial equilibrium approaches. Applications may be varied for different types of approaches.
While the partial equilibrium models keep simplicity and are useful for study purposes in an isolated market, general equilibrium models give an overall view by capturing interdependencies among markets in an economy.
Economists and policymakers move to the right tool for analyzing their specific economic situations, keeping them well-equipped with knowledge for taking informed decisions.