Developments in Major Fields of Economics
Edited by Gilbert Faccarello and Heinz D. Kurz
Chapter 19: General equilibrium theory
When, in some discipline, we arrive at a fully fled ged, internally consistent model, we have a tendency to assume that such a model was the inevitable consequence of progress in that discipline. Einstein, quoted by Hahn (1974: 23), observed that: Creating a new theory is not like destroying an old barn and erecting a skyscraper in its place. It is rather like climbing a mountain, gaining new and wider views, discovering new connections between our starting point and its rich environment. But the point from which we started still exists and can be seen, although it appears smaller and forms a tiny part of our broad view gained by the mastery of the obstacles on our way up. This suggests that there was only one mountain to climb and that each hard-won vertical metre gave us a better and fuller understanding of the world. Yet general equilibrium theory and its evolution illustrates perfectly the difficulties with this view. What do we mean now by general equilibrium theory? A concise definition might be the study of those states of an economy where “rational” optimizing, and isolated individuals and firms make choices subject to constraints, where the constraints are determined by the prices of goods and factors, where these prices are known to all agents, and where no agent has an incentive to change his choice. Furthermore, the states are described as “equilibria” if the quantities of goods demanded are equal to the quantities of goods or resources produced or naturally available. The questions that then arise are: do such states exist and what are their properties? How many are there? Will the economy reach them?
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