EQUILIBRIUM IN ECONOMICS

A
PROJECT REPORT ON
EQUILIBRIUM IN ECONOMICS

SUBMITTED TO:
Ms. Kiran Bala Das
(Faculty Economics)

Submitted By:
Vivek Kumar Pandey
`Roll No. : 174
Semester- I

Date of Submission:19th of September 2011

Hidaytullah National Law University Raipur
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 EQUILIBRIUM IN ECONOMICS

Table of Contents

 Acknowledgement………………………………………………………………………iii
 Statistical Tools………………………………………………………………………….iv
 Research Methodology……….……………………………………………………...….iv
 Introduction…......…………………………………………………………………..…..1
 Objective

1. To Study General and Partial Equilibrium.

1.1 General Equilibrium………………………………………..….…………….…...2

1.2 Uses of General Equilibrium……………………………..……………….……..3

1.3 Limitations of General equilibrium analysis………….………………….….….4

1.4 Partial Equilibrium……….……………………………………………………....5

1.5 Difference between Partial and General Equilibrium………………………….6

1.6 Graph For General and Partial Equilibrium…………………………………...7

2. To Discuss Producer and Consumer Equilibrium

2.1 Producer Equilibrium……………………………………………………………7

2.2 Consumer Equilibrium…………………………………………………………..8

2.3 Graph for Consumer and Producer Equilibrium ……………………………..9

3. To Study Static and Dynamic Equilibrium

3.1 Static Equilibrium……………………………………………………………….10

3.2 Dynamic Equilibrium……………………………………………………………10

 Suggestion……………………………………………………………………………….12
 Conclusion………………………………………………………………………………13
 Bibliography…………………………………………………………………………….14

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 EQUILIBRIUM IN ECONOMICS

ACKNOWLEDGEMENTS

First & foremost, I take this opportunity to thank Ms. Kiran Bala Das, Faculty, Political Science,
HNLU, for allotting me this challenging topic to work on. She has been very kind in providing
inputs for this work, by way of suggestions and by giving her very precious time for some
discussion and providing me resource of her vast knowledge of the subject which helped me to
look at the topic in its very broad sense also to look at some of the very narrow concepts by
expertise view. Therefore She proved to be a database in making this project. Hence I would like
to thank her.

I would also like to thank my dear colleagues and friends in the University, who have helped me with
ideas about this work and also a source for constant motivation and hence they were a guiding force to
me in making of this project . Last, but not the least I thank the University Administration for equipping
the University with such good library and IT lab.

My special thank to library staff and IT staff for equipping me with the necessary books and data from
the website.

I would also like to thank the hostel staff for providing me a healthy and clean environment that
provided me a great concentration level.

Vivek Kumar Pandey

Roll No. - 174

Semester- I

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 EQUILIBRIUM IN ECONOMICS

Research Methodology

This research paper is descriptive & analytical in approach. It is largely based on secondary &
electronic sources. Books & other reference as guided by faculty of Economics are primarily
helpful for the completion of this project.

STATISTICAL TOOLS
In making of this Project in form of statistical tools only graphs are used.

OBJECTIVES
 To study the Static and General Equilibrium.
 To Discuss Producer and Consumer Equilibrium.
 To Study Static and Dynamic Equilibrium.

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 INTRODUCTION

In economics, economic equilibrium is a state of the world where economic forces are balanced
and in the absence of external influences the (equilibrium) values of economic variables will not
change. It is the point at which quantity demanded and quantities supplied are equal 1. The
concept of an economic equilibrium is fundamentally very complex and subtle.  The goal is to
derive the outcome when the agents described in a model complete their process of maximizing
behavior.  Determining when that process is complete, in the short run and in the long run, is an
elusive goal as successive generations of economists rethink the strategies that agents might
pursue. At its simplest, however, we often find an equilibrium at the intersection of two or more
lines.  The explanation is this.  Suppose line A represents the optimizing behavior of one
group of agents, and suppose line B represents the optimizing (make the effective) behavior
of another group of agents.  Then, the intersection of lines A and B is the equilibrium
where both groups of agents are optimizing. The classic example is supply and demand. 
The supply curve shows the quantity supplied at a given price by profit-maximizing firms.  The
demand curve shows the quantity demanded at a given price by utility-maximizing consumers. 
The intersection of the supply curve and the demand curve is the point that maximizes both
profits and utility.2

1
HAL R. VARIAN, MICROECONOMIC ANALYSIS, 6, (3d ed.1992)
http://en.wikipedia.org/wiki/Economic_equilibrium accessed on 15th of September 2011 at 05:15pm

2
William R. Parke. 
http://www.econmodel.com/classic/terms/equilibrium.htm accessed on 15th of September 2011 at 05:15pm

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1. General and Partial Equilibrium.

1.1 General Equilibrium.

General equilibrium theory is a branch of theoretical economics. General equilibrium theory is

a branch of theoretical microeconomics.  It seeks to explain the behavior of supply, demand
and prices in a whole economy with several or many interacting markets, by seeking to
prove that a set of prices exists that will result in an overall equilibrium, hence general
equilibrium, in contrast to partial equilibrium, which only analyzes single markets. As with
all models, this is an abstraction from a real economy; it is proposed as being a useful model,
both by considering equilibrium prices as long-term prices and by considering actual prices as
deviations from equilibrium. 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. General equilibrium is different from the aggregate or macro-economic
equilibrium.  General equilibrium tries to give an understanding of the whole economy
using a bottom-top approach, starting with individual markets and agents.  Whereas, the
macro-economic equilibrium analysis utilises top-bottom approach, where the analysis
starts with larger aggregates.  In macro-economic equilibrium models, the entire system is
described by relatively few, appropriately defined aggregates and functional relationships
connecting aggregate variables such as total consumption expenditure, total investment, total
employment, aggregate output and the like.  In macro-economic analysis, many important
variables and relationships tend to be disappeared in the process of aggregation. 3 The economy’s
general equilibrium contains a logical structure behind the millions of markets determining
prices and outputs: (a) Households which want to maximize their satisfactions, supply factors
and buy produce while (b) firms are 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.4

3
http://www.oocities.org/znuniverse/micro_economics/equilibrium.htm accessed on 15 th of September 2011 at
05:15pm
4
SAMUELSON NORDHAUS, ECONOMICS, 284, (18h ed. 2005)

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1.2 Uses of General Equilibrium.

1.      To get an overall picture of the economy and study the problems involving the economy
as a whole or even large segments / sectors of it.

2.      It shows that the quantities of demanded goods / factors are equal to the quantities
supplied.  Such a condition implies that there is a full employment of resources.

3.      It also provides with an ideal datum of economic efficiency.  It brings out the fact that
long-run competitive equilibrium is a standard of efficiency for the entire economy.  Only
when the competitive economy obtains general equilibrium shall its economic efficiency be at its
peak and there shall be no further gains made by any reallocation of resources.

4.      General equilibrium also represents the state of optimum production of all commodities,
because there can be no over-production or under-production under such conditions./

5.      It also provides an insight into the way the multitudes of individual decisions are integrated
by the working of the price mechanism.  It, therefore, solves the fundamental problems of a
free market economy, viz., what to produce, how to produce, how much to produce, etc. 
This analysis shows that such decisions with regard to innumerable consumers and producers are
co-ordinated by the price mechanism.

6.      The general equilibrium analysis also gives us the clue for predicting the consequences
of an economic event.

7.      It also helps in the field of public policy.  The formulation of a logically consistent public
policy requires a complete understanding of the various sector markets and aspects of individual
decision-making units, and the impact of policy on the whole economy.

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1.3 Limitations of General Equilibrium Analysis

1.      The Walrasian general equilibrium system is essentially static.  It treats the coefficient of
production as fixed.  It considers the supply of resources to be given and consistent. It also takes
tastes and preferences of the society as fixed.

2.      It ignores leads and lags, for it considers everything to happen instantaneously.  It is
supposed to work just in the same way as an electric circuit does.  In the real world, all economic
events have links with the past and the future.

3.      Walrasian general equilibrium analysis is of little practical utility.  It involves astronomical
volumes of calculations for estimating the various quantities and practices.  This makes its
application practically impossible.  Even the use of computers cannot be of much help because
such a system cannot aid in collecting and recording the innumerable sets of prices and quantities
that are required to formulate these equations.  The critics further argue that even if such a
solution exists, the price mechanism may not necessarily cover it.

4.      Last but not least, the general equilibrium analysis falls to the ground as its star assumption
of perfect competition is contrary to the actual conditions prevailing in the real world.

1.4 Partial Equilibrium

A partial equilibrium is a type of economic equilibrium, where the clearance on the market of
some specific goods is obtained independently from prices and quantities demanded and supplied
in other markets. In other words, the prices of all substitutes and complements, as well as income
levels of consumers are constant. Here the dynamic process is that prices adjust until supply
equals demand. It is a powerfully simple technique that allows one to study equilibrium,
efficiency and comparative statics. The stringency of the simplifying assumptions inherent in this
approach make the model considerably more tractable, but may produce results which, while
seemingly precise, do not effectively model real world economic phenomena. 5 Partial
equilibrium analysis is the analysis of an equilibrium position for a sector of the economy or for

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one or several partial groups of the economic unit corresponding to a particular set of data.  This
analysis excludes certain variables and relationship from the totality and studies only a few
selected variables at a time.  In other words, this method considers the changes in one or two
variables keeping all others constant, i.e., ceteris paribus (others remaining the same).  The
ceteris paribus is the crux of partial equilibrium analysis. The equilibrium of a single consumer, a
single producer, a single firm and a single industry are examples of partial equilibrium analysis

Few statements of partial equilibrium analysis, which examines the behaviour of a single market,
household, or firm taking the behaviour all other markets and rest of the economy as given.
These statements will help to understand the concept of partial equilibrium analysis:

 Competitive supply and demand operate to determine prices and quantities in

individual market.
 Market demand curves are derived from the marginal utilities of different goods.
 The marginal costs of different commodities lie behind their competitive curves.
 Firms calculate marginal costs of products and marginal revenue products of
factors and then choose inputs and outputs so as to maximize profits.
 These marginal revenue products, summed for all firms, provide the derive demands for
the factors of production.
 These derived demands for lands, labor, or capital good interact with their market
supplies to determine factor prices such as rent, wages, and interest rates.

1.5 Difference between partial and general equilibrium.

(a) General equilibrium theory is a branch of theoretical microeconomics.  The partial
equilibrium analysis studies the relationship between only selected few variables, keeping others
unchanged.
(b) Whereas the general equilibrium analysis enables us to study the behaviour of economic
variables taking full account of the interaction between those variables and the rest of the
economy.  In partial equilibrium analysis, the determination of the price of a good is simplified
by just looking at the price of one good, and assuming that the prices of all other goods remain
constant.

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1.6 Graph for general and partial equilibrium.

General equilibrium.

The IS curve moves to the right, causing higher interest rates (i) and expansion in the "real"
economy (real GDP, or Y).The IS/LM model (Investment Saving/Liquidity preference Money
supply) is a macroeconomic tool that demonstrates the relationship between interest rates and
real output in the goods and services market and the money market. The intersection of the IS
and LM curves is the "General Equilibrium" where there is simultaneous equilibrium in both
markets.

Partial Equilibrium.

The price P of a product is determined by a balance between production at each price (supply S)
and the desires of those with purchasing power at each price (demand D). The diagram shows a
positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q)
of the product.

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The supply-demand model is a partial equilibrium model representing the determination of the
price of a particular good and the quantity of that good which is traded. Although it is normal to
regard the quantity demanded and the quantity supplied as functions of the price of the good, the
standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical
axis and quantity on the horizontal axis, the opposite of the standard convention for the
representation of a mathematical function.

2 Production And Consumer Equilibrium.

2.1 Producer Equilibrium:

The producer equilibrium refers to the situation in which firm maximizes his profit.6
P = TR-TC
Here P = profit, TR= Total Revenue, TC=Total cost.
It occurs when profits are maximized i.e., the difference between TR and TC is maximized or
when losses are minimized.

6
T.R.JAIN and V.K.OHIRI, INTRODUCTORY MICROECONOMICS AND MACRO ECONOMICS, , 164,
(7h ed. 2009-10)

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 For description and details of how a producer attains his equilibrium. It is necessary to
understands the concepts of cost and revenue, and the behavior of these parameters in the context
of a perfectly competitive market. Briefly it can be stated that, under perfect competition, a firm
is a price taker. Accordingly, firm’s AR curve (or firm’s demand curve) is a horizontal straight
line. AR is given to a firm. Constant AR implies that AR=MR, and that TR increases at a
constant rate. Cost curves, of course, are in accordance with the laws of production. Short period
AC is U-shaped in accordance with the law of Variable Proportions and long period AC is U-
shaped in accordance with the Returns to Scale.

The discussion on producer’s equilibrium is split into two sections, one focusing on short-run
equilibrium and the other focusing on long-run equilibrium.

Short period: Short period is a period of time in which the new firms cannot join the industry and
existing firms cannot leave the industry. Accordingly, number of firms in the industry remains
constant during the short period.7

Long period- Long period is a period of time which is long enough for new firms to leave the
industry. Accordingly the number of firms in the industry keeps changing.8

2.2 Consumer Equilibrium.

When consumers make choices about the quantity of goods and services to consume, it is
presumed that their objective is to maximize total utility. In maximizing total utility, the
consumer faces a number of constraints, the most important of which are the consumer's income
and the prices of the goods and services that the consumer wishes to consume. The consumer's
effort to maximize total utility, subject to these constraints, is referred to as the consumer's
problem. The solution to the consumer's problem, which entails decisions about how much the
consumer will consume of a number of goods and services, is referred to as consumer
equilibrium.

Determination of consumer equilibrium: Consider the simple case of a consumer who cares
about consuming only two goods: good 1 and good 2. This consumer knows the prices of goods

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1 and 2 and has a fixed income or budget that can be used to purchase quantities of goods 1 and
2. The consumer will purchase quantities of goods 1 and 2 so as to completely exhaust the
budget for such purchases. The actual quantities purchased of each good are determined by the
condition for consumer equilibrium, which is

The term consumer’s equilibrium refers to the amount of goods and services which the consumer
may" buy in the market given his income and given prices of goods in the market".

A consumer is said to be in equilibrium at a point where the price line is touching the highest
attainable indifference curve from below".

2.3 Graph for consumer and production Equilibrium.

3 Static and Dynamic Equilibrium

3.1 Static Equilibrium

Notion of equilibrium is that, it’s a state of rest, characterized by movement where opposite
forces are counteracting each other. Once this position is reached there is no tendency to move

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away from it. According to professor Mehta “Static Equilibrium is the Equilibrium which
maintains itself outside the period of time under consideration”. 9It is a state of bliss which every
individual firm, industry or factor wants to attain and once reached, would not like to leave. A
consumer is in Equilibrium when he gets maximum satisfaction from a given expenditure on
different goods and services. Any move on his part to reallocate his expenditure among his
purchases will decrease rather than increase his total satisfaction. A firm is in Equilibrium when
their profits are the maximum and it has no incentive to expand or contract its output. Any
deviation from this position will lead to
Diminution in profits. Similarly, an industry is in equilibrium where it has no incentive to change
its total output. It is a position in which neither the existing firms have any tendency to leave nor
for new firms to enter the industry. In other words an industry is in equilibrium when all firms
are earning only normal profits. A productive resource is in equilibrium when it is employed in
its highest paid employment so that its income is maximized. It has no incentive to offer more or
less of its service and not to seek elsewhere. If it does so, it will reduce its income. Professor
Boulding has explained static equilibrium in these words “A mechanical analogy may be found
in a ball rolling at a constant speed or better still of a forest in equilibrium in these equilibrium
where tree sprout grows or dies but where composition of the forest as a whole remains
unchanged”.10 Or, a train running at a constant speed. This is Static Equilibrium, which is based
on given, and constant prices, quantities, income, tastes, technology, population etc.

3.2 Dynamic Equilibrium.

In dynamic Equilibrium prices, Quantities, incomes, tastes, technology, etc are constantly
changing. Thus over a period of time, a state of disequilibrium rather than of equilibrium is to be
found. If there is disagreement in the decision being made by some of the market participants, it
tends to alter the existing equilibrium situation, there is disequilibrium. Those participants who
are in disequilibrium in their efforts to reach the equilibrium in their efforts to reach the
equilibrium the position throw others into disequilibrium. Thus a chain reaction sets in, which
ultimately brings the decisions of all the participants in harmony and a new equilibrium position

9
M.L.JHINGAN, MICROECONOMIC THEORY, 116, (5h ed. 1999)
10
K.E.BOULDING,EQUILIBRIUM FUNDAMENTAL, 45,(3d ed. 1995)

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is established. As when after a fixed period equilibrium state is disturbed it is called dynamic
equilibrium

To continue, suppose some persons develop the taste for fish as a result the demand for fish will
increase. It will upset the previous plans and dispositions of all the participants in the market.
Sellers will at once raise the price and thus change the behavior of the old buyers. The market
will be thrown into a state of disequilibrium and will remain so till the supply of fish is increased
to the level of new demand, when new equilibrium will be brought by the contending force

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 SUGGESTION’S

Equilibrium in economics is nothing but the satisfaction and maximization. Satisfaction

for the consumer who by his means of money wants to achieve all ends of his desire and
wanted to accomplish maximum satisfaction, and producer who by means of production
wants to maximize his profit by satisfying the demand of consumer by the means of supply.

Although practically the equilibrium in economics cannot be achieved but theoretically, yes it
can be achieved? While stating this that equilibrium cannot be achieved in practical aspects the
author wants to bring the true taste of economics which when inferred can be stated that
human’s desire, wishes, wants etc are unlimited which by the use of scarce means of
resources cannot be achieved because of the basic human nature that characterizes greed
and unlimited wants.

Therefore author through this project wants to clear this concept of equilibrium in economics
which will ultimately be beneficent to society as achievement of equilibrium in economics
clearly mean that there is neither any profit nor any loss, and it can be explained in a better
way that it’s a end of human desire or his greed since equilibrium is achieved human
satisfaction is satisfied.

After the accomplishment of equilibrium a better society can be constructed where there is
enough for all other member of society including every group and there are no clashes of
interest in different group among society. Law and order can be imposed in a far better
way and hence peace can be brought in our society which will bring happiness to
consumers and also the producer who by the means of latest equipment, machineries,
technology, labor, investment, etc tries every possible outcome to make society better place
to live as a society will be a better place to live when it is satisfied or there is supply equal to
the demand that is a state of economic concept which we termed as Equilibrium.

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 CONCLUSION

Hence with this it can be concluded that economics as a subject derives its soul from the concept
of equilibrium. Equilibrium is an hypothetical condition which cannot be achieved by any means
but if achieved can be very resourceful to the society.

Bibliography
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  SAMUELSON NORDHAUS, ECONOMICS, 284, (18h ed. 2005).
 M.L.JHINGAN, MICROECONOMIC THEORY, 116, (5h ed. 1999).
 K.E.BOULDING,EQUILIBRIUM FUNDAMENTAL, 45,(3d ed. 1995).
 T.R.JAIN and V.K.OHIRI, INTRODUCTORY MICROECONOMICS AND MACRO
ECONOMICS, 164, (7h ed. 2009-10).

Webliography

 http://en.wikipedia.org/wiki/Economic_equilibrium
 http://www.econmodel.com/classic/terms/equilibrium.htm
 http://www.oocities.org/znuniverse/micro_economics/equilibrium.htm

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