Partial equilibrium models form part of the tool kit of economics. They analyse the behaviour of a single market while keeping other markets constant.
Actually, such an idea was invented by the great economist Alfred Marshall. Isolating one market and analysing the supply-demand dynamics in it makes economic systems so much simpler for this kind of study.
This model is often used in the analysis of specific industries or specific commodities. It allows for a simpler study on the pricing, output and welfare effects when complications arising from more general economic interdependencies need not be considered.
In this article, we shall discuss the basics, how partial equilibrium models work, their applications, and what their limitations are.
Understanding Partial Equilibrium Models
A partial equilibrium model studies an equilibrium condition of a single market as an isolated case, based on mutual interaction between only supply and demand in a given market, thereby saving it from the effects of backward linkage from other markets.
It examines how these price and quantity equilibria are generated with the supposition “ceteris paribus,” meaning changes in other markets do not affect the one being studied.
For example, if we are doing partial equilibrium for the market for wheat, we assume that adjustments in the market for wheat don’t affect things such as labour costs or other crops prices (such as corn or rice).
Now one can easily understand through this kind of isolation of any market what the immediate effects would be when there are variations in supply changes or demand changes of the prices and quantities.
Basic Constituents of Partial Equilibrium Models
The partial equilibrium model works on a number of simple principles:
1. Demand and Supply Curves
The model requires information about demand curves as well as supply curves in a given market.
It is through these curves that people represent their demand relationship with price and quantity, and similarly for supply, the related quantities supplied and price.
Equilibrium occurs where these two curves intersect.
2. Equilibrium Price and Quantity
The model comes out showing the equilibrium price and quantity in terms of which point simultaneously determines at what level the demand and supply curves intersect, or rather the exact point where consumers are willing to buy the given quantity that producers are also willing to sell.
3. Elasticity of Demand and Supply Understanding elasticities
it means how much sensitive the quantity demanded or supplied is to the changes in price-is very important in partial equilibrium analysis.
You should know that if the demand for some product is elastic, then a small change in price will cause a considerable amount of change in quantity demanded.
4. Market Shocks and Adjustments
One of the areas where partial equilibrium models are very helpful is in determining a market’s adjustments to external shocks such as changes in production costs, taxes, subsidies, or shifts in consumer preferences.
In this approach, through modelling, one can accurately forecast changes in equilibrium price and quantity.
Applications of Partial Equilibrium Models
Partial equilibrium models have several applications in various fields owing to its simplicity and concentration. The major applications include:
1. Policy Analysis
Governments use partial equilibrium models in order to analyse the policy impacts of taxing, subsidizing, or price control measures on specific markets.
For example, a policymaker can use a partial equilibrium model to study the new subsidy that has been introduced on renewable energy, thereby analysing how it alters the energy prices, production level, and welfare of the consumer.
2. Studies for specific markets
Partial equilibrium models are widely applied in firms whose boundaries have well-defined borders, such as agriculture, oil, and pharmaceuticals.
These are analyses that are helpful for researchers in suggesting how changes within those markets affect prices and output without taking into account broader economic factors.
3. Welfare Analysis
Using partial equilibrium models, you can compute consumer and producer surplus, which enables one to judge the welfare implications of a host of economic events. Calculating the area under demand and supply curves will quantify the benefits derived by consumers and producers from transactions at equilibrium prices.
4. Environmental Economics
Partial equilibrium models can be applied to environmental economics where partial equilibrium models are used to analyse the impact of environmental policies on some markets. A researcher can study the impact of a carbon tax on the energy market. They can look at the change in the prices of fossil fuels and how clean alternatives will be promoted.
Limitation of Partial Equilibrium Models
Partial equilibrium models are helpful but a few drawbacks:
1. Isolation Assumption
The major assumption is that others’ markets are isolated. Markets really are interactive, so changes in one often spur overflows into others.
For example, increasing the price for wheat may change the price of corn, because producers will shift resources to grow more wheat.
2. Ignores General Equilibrium Effects
Partial equilibrium analysis does not take into account general equilibrium effects, which examine how the changes affect several markets. General equilibrium models are more comprehensive,
for example, it takes into account how changes in one market will affect the broader economy; however, they are also quite complex and so data-intensive.
3. Over-Simplification of Intragroup Relationships
Partial equilibrium models focus only on a single market. Thus, it may result in some economic forces becoming over-simplified.
Subsequently, it may lead to the giving of false predictions in circumstances involving several interlinked markets of impacts on demand and supply.
4. Static Nature
Many partial equilibrium models are static because they look at a single point in time. They do not capture the dynamic adjustments occurring as markets move toward a new equilibrium following a shock.
Conclusion
Partial equilibrium models form a simple yet powerful framework for analysing individual markets by isolating them from the complexities of the broader economy.
They are extremely useful tools for policy analysis, industry-specific studies, and welfare analysis.
With it the economist and policymakers can easily understand how a change in demand, supply, or policy affects prices and output in a given market. Still, partial equilibrium models are excellent for focused analysis but have limitations due to their assumptions and simplifications.
For example, the scenarios depicted can become much more complex and dependent on how many markets are in play for the economists applying general equilibrium models that have complex interplay among multiple markets.
Partial equilibrium models mainly offer an intuitive way of understanding the outcome regarding an individual market.
Although partial equilibrium models are very common in many areas of economics, any interpreter should be aware of such assumptions and limitations pertaining to the results derived.