Partial equilibrium theory analyzes small markets and assumes changes in one market have no effect on others. General equilibrium theory examines how changes in each market affect related markets. The former is useful for research, while the latter is used to determine the price point where supply and demand are balanced in all markets.
Partial equilibrium is an economic theory used to analyze very small markets or single products. This theory requires economists to ignore all markets outside the one studied, and to assume that changes in that particular market will have no effect outside that market, and vice versa. Partial equilibrium theory provides a useful model for research and analysis, but is generally not effective in real-world scenarios. For broader studies of the market as a whole, economists rely on the broader concept of general equilibrium, which examines how changes in each market affect events in related markets.
The first general equilibrium models were developed by the French economist Leon Walras in the 1870s. It was not until the 1920s and 1930s that economists attempted to study markets in isolation using partial equilibrium models. Antoine Cournot of France and Alfred Marshall of England are generally credited with being the first economists to publish theories on partial equilibrium analysis.
A market is said to be in equilibrium when demand meets supply. This occurs when producers find the equilibrium price for each product. Since consumers have only a limited income, price changes for one product could affect how much money they have left to spend on other products, which could affect supply and demand. Partial equilibrium models ignore this concept and assume that changes in a single market have no influence on other products or markets.
This theory can be effectively applied to very small markets or products. For example, this model could be used to help a small-town bread producer determine the equilibrium price for his product by balancing supply and demand. This example fits this model because it involves a very small market compared to the overall economy and also because it does not involve limited resources. In most cases, a small baker who increases production or changes his prices will have little impact on other markets or on the availability of flour and other ingredients. Using partial equilibrium theories, this same baker could have a huge impact on his bottom line by finding the price where supply and demand are equal.
General equilibrium theory, on the other hand, helps economists determine the price point where supply and demand are balanced in all markets and products. This model accepts that for most products, a change by one manufacturer will impact a large volume of other markets. For example, if a baker who supplied bread to stores across the country decided to cut his production rates in half, that nation’s supply of bread could be insufficient to meet the demand. Bread prices would rise and consumers would have less money to spend on other goods. This could affect prices and production rates for all types of consumer goods.
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