Partial and general equilibrium, law of demand and demand analysis

2.6.3 Computing general equilibrium

2.7 Partial equilibrium

In many cases PE doesn’t make sense, but in others it is a very useful tool to anticipate the main effects of a policy. Generally, the more narrowly we define a market, the more appropriate PE analysis is. So, PE of a tax on pencils is normally viewed as more reasonable than PE analysis of a broadbased tax like the GST. In the former case, it’s probably unlikely that a tax on pencils will cause significant changes in the price of substitutes (pens and printers) or inputs (graphite or wood), so the maintained assumption that no other prices change in response to the policy is likely a good one.

Note that in the case of a broad-based tax like the GST, such an assumption is not reasonable.
Assumptions
In what follows, we will make a lot of strong assumptions to make the analysis clearer (and normally simpler too). These assumptions include:
• The market under consideration is for a private good (like clothing or food or paper) and there is no trade (imports or exports).
• All product and factor markets are perfectly competitive.
• Production exhibits non-increasing returns to scale.
• There are no externalities associated with the production or consumption

of the goods.

curve.

• 
  New simple data-analytic techniques for analyzing consumption data;
  

• 
  New tests based on computer simulations for hypothesis testing;
  

• 
  New methodological results on how to estimate demand equations;
  

• 
  Innovative applications to alcohol demand;
  

• 
  Extension of the system-wide framework to analyze the effects of advertising on consumption;
  

• 
  And novel approaches to forecasting consumption patterns; and new theoretical results on aggregation of demand systems over consumers.
  

1. 
   Explain how supply and demand interact to determine equilibrium price and output?
   
2. 
   Discuss the assumptions behind demand and supply Model.
   
3. 
   What do you understand by aggregate demand? How it is related to aggregate supply
   
4. 
   Distinguish between general and partial equilibrium approaches.
   

• 
  Callan, S.J & Thomas, J.M. (2007). 'Modelling the Market Process: A Review of the Basics', Chapter 2 in Environmental Economics and Management: Theory, Politics and Applications, 4th ed., Thompson Southwestern, Mason, OH, USA
  
• 
  Case, Karl E. and Fair, Ray C. (1999). Principles of Economics (5th ed.).
  
• 
  Mas-Colell, Andreu, Michael D. Winston, and Jerry R. Green. Microeconomic Theory. Oxford University Press, New York, 1995.
  
• 
  Varian, H. (1992) Microeconomic Analysis, Third edition, New York: Norton
  

After studying this unit, you should know the:

• 
  Basic approaches to the concept of demand
  
• 
  The theory of utility
  
• 
  The relevance of Income and Substitution Effect
  
• 
  The concept of indifference curve and revealed Preference
  
• 
  The slutsky theorem and its relevance in real world situations
  
• 
  The Hicks theory and its assumptions
  
• 
  Price Formation and Discovery
  

3.1 Introduction

3.2 The Utility Theory

3.3 Income and substitution Effect

3.4 Indifference Curve

3.5 Revealed Preference

3.6 The Slutsky Theorem

3.7 The Hicks Theory

3.8 Price Formation and Discovery

3.9 Summary

3.10 Further Readings
3.1 INTRODUCTION
Demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship

In this unit we are going to discuss certain main approaches to Demand and relative theories to it. Further some important aspects that directly or indirectly affect the demand will also be discussed.

In economics, utility is a measure of the relative satisfaction from, or desirability of, consumption of various goods and services. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain economic behavior in terms of attempts to increase one's utility. For illustrative purposes, changes in utility are sometimes expressed in units called utils.

The doctrine of utilitarianism saw the maximization of utility as a moral criterion for the organization of society. According to utilitarians, such as Jeremy Bentham (1748-1832) and John Stuart Mill (1806-1876), society should aim to maximize the total utility of individuals, aiming for "the greatest happiness for the greatest number of people". Another theory forwarded by John Rawls (1921-2002) would have society maximize the utility of the individual receiving the minimum amount of utility.

In neoclassical economics, rationality is precisely defined in terms of imputed utility-maximizing behavior under economic constraints. As a hypothetical behavioral measure, utility does not require attribution of mental states suggested by "happiness", "satisfaction", etc.

Utility can be applied by economists in such constructs as the indifference curve, which plots the combination of commodities that an individual or a society would accept to maintain a given level of satisfaction. Individual utility and social utility can be construed as the dependent variable of a utility function (such as an indifference curve map) and a social welfare function respectively. When coupled with production or commodity constraints, these functions can represent Pareto efficiency, such as illustrated by Edgeworth boxes in contract curves. Such efficiency is a central concept of welfare economics.