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Lecture 11: General equilibrium ECON 201 Microeconomic Theory I I nstructor: Fernando Aragon `
IntroducDon 15 Our analysis of markets thus far has been focused on individual markets; this is called partial equilibrium analysis . Determination of the equilibrium in a single market assuming there are no cross-market spillovers One exception: consideration of cross-price elasticities Most markets are linked to others in important ways. For example, increased labor demand from one industry increases the wage for all workers, regardless of their industry. Ignoring cross-market effects simplifies the analysis but is unrealistic. In this chapter, we introduce general equilibrium analysis . A study of market behavior that incorporates cross-market influences to determine the equilibrium
General Equilibrium Effects in Action 15.1 General equilibrium analysis has two parts. 1. Positive analysis describes the mechanics of market interactions. 2. Normative analysis offers definitions of equity and efficiency that allow policy makers to analyze how different equilibria affect different members of society.
General Equilibrium Effects in Action 15.1 An Overview of General Equilibrium Effects Consider the Energy Policy Act of 2005 This legislation set mandates for the use of biofuels in gasoline blends. At least 4 gallons of ethanol required in gasoline blends in 2006, ramping up to 7.5 gallons by 2012. These were binding minimums, meaning that normal market forces would have likely resulted in less ethanol being used. As expected, the mandate increased demand for corn, hence the price. However, the prices of wheat, rice, and soybeans also increased during this period.
General Equilibrium Effects in Action 15.1 Why would we expect the price of other commodity crops to increase? As demand for corn increases, the price increases. As the price increases, consumers demand more of substitute goods. For instance, wheat-based cereals versus corn-based As demand for other commodities increases, the demand for corn increases further. These effects can be depicted graphically.
General Equilibrium Effects in Action 15.1 Figure 15.1 General Equilibrium Effects in Corn and Wheat Markets (a) Corn Market (b) Wheat Market Price of corn Price of wheat ($/bushel) S c 1 ($/bushel) S w1 P wF P cF P c 3 P w 3 P c 2 P w 2 P c 1 P w 1 D cF D wF D c 3 D w 3 D c 2 D w 2 D w 1 D c 1 Quantity of corn (bushels) Quantity of wheat (bushels) Q cF Q c 3 Q c 2 Q c 1 Q wF Q w 3 Q w 2 Q w 1 The ethanol mandate shifts corn demand outward, and the rise in corn prices increases the demand for wheat. Higher wheat prices further increase demand for corn. This process continues until a Hinal equilibrium is reached.
General Equilibrium Effects in Action 15.1 Why else might the price of other commodity crops increase?

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