Page 386 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-26: General Equilibrium Theory

9. There is no perfect competition in product and service market. Notes
10. There is no externality of production or consumption.

26.3 2 × 2 × 2 Graphical General Equilibrium Model
Below we have studied a graphical condition of a static perfect competitive economy in which there are
two consumers, two products and two factors. This is called 2 × 2 × 2 equilibrium model.

Its Assumptions
This model is based on following assumptions—
1. There is perfect competition in product and service market.
2. Labour and capital are two similar and completely divided factors of production. Both are
available in fixed quantity.
3. Both the factors are in full employment.
4. Only two similar products X and Y are produced in economy. These products are available in
limited quantity. The production equation of every product has given and does not change.
Every production shows fixed factors of scale. There is MRTS with any Isoquant curve. It means
that Isoquant curve is convex to its origin.
5. There is no externality of production.
6. There are two consumers A and B in economy which consume all quantities of X and Y. Every
consumer has a set of convex indifference curves towards origin.
7. There is no externality of consumption.
8. Every consumer wants to maximize his satisfaction on a given income.
9. The consumer is owner of both the form of production.
10. Every firm (producer) wants to profit maximization on a given production equation.
On these given assumption, the economic is in general equilibrium state when two product markets
and two factor markets, and two consumers and two firms individually are in equilibrium in a set.
There are three characteristics of this general equilibrium model—(i) General Equilibrium of Exchange
or Consumption (ii) General Equilibrium of production and (iii) General Equilibrium of Exchange and
Production.

Give your views on Walrasian General Equilibrium Model.

(i) General Equilibrium of Exchange or Consumption

To general equilibrium of exchange, it is necessary that the marginal substitutional rate of two products
should be equal and consumes both the products. It means MRS should be equal to its average price
between two consumer products. Since in perfect competition, every consumer wants to maximize his
satisfaction, so he will equal to his MRS to its average price (P /P ) for product X and Y. In this model,
x
y
if there two consumers A and B, two products X and Y and on given price average P /P , the general
x
y
equilibrium comes when consumer A selects X and Y like MRS = P /P and consumer B selects X and
A
XY
x
y
Y like MRS = P /P . So, the condition of general equilibrium for both the consumers:
B
XY
x
y
MRS = MRS = P /P .
A XY B XY x y
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