What is the 'General Equilibrium Theory'

General equilibrium theory, or Walrasian general equilibrium, attempts to explain the functioning of economic markets as a whole, rather than as individual phenomena. The theory was developed by the French economist Leon Walras. It stands in contrast with partial equilibrium theory, or Marshellian partial equilibrium, which only analyzes specific markets.

BREAKING DOWN 'General Equilibrium Theory'

Walras developed general equilibrium theory to solve a much-debated problem in economics. Up to that point, most economic analyses only demonstrated partial equilibrium — the price at which supply equals demand and markets clear — in individual markets. It was not yet shown that equilibrium could exist for all markets at the same time.

Uses of General Equilibrium Theory

General equilibrium theory tried to show how and why all free markets tended toward equilibrium in the long run. The important fact was that markets didn't necessarily reach equilibrium, only that they tended toward it. As Walras wrote in 1889, “The market is like a lake agitated by the wind, where the water is incessantly seeking its level without ever reaching it.”

General equilibrium theory builds on the coordinating processes of a free market price system, first widely popularized by Adam Smith's “The Wealth of Nations” (1776). This system says traders, in a bidding process with other traders, create transaction by buying and selling goods. Those transaction prices act as signals to other producers and consumers to realign their resources and activities along more profitable lines.

Walras, a talented mathematician, believed he proved that any individual market was necessarily in equilibrium if all other markets were also in equilibrium. This became known as Walras’ Law.


There are many assumptions, realistic and unrealistic, inside the general equilibrium framework. Each economy is considered to have a finite number of goods in a finite number of agents. Each agent has a continuous and strictly concave utility function, along with possession of a single pre-existing good (the “production good”). In order to increase his utility, each agent must trade his production good for other goods to be consumed.

There is a specified and limited set of market prices for the goods in this theoretical economy. Each agent relies on these prices to maximize his utility, thereby creating supply and demand for various goods. Like most equilibrium models, markets lack uncertainty, imperfect knowledge or innovation.

Alternatives to General Equilibrium Theory

Austrian economist Ludwig von Mises developed an alternative to long-run general equilibrium with his so-called Evenly Rotating Economy (ERE). This was another imaginary construct and shared some simplifying assumptions with general equilibrium economics: no uncertainty, no monetary institutions and no disrupting changes in resources or technology. The ERE was designed to illustrate the necessity of entrepreneurship by showing a system where none existed.

Another Austrian economist, Ludwig Lachmann, argued the economy is an ongoing, non-stable process replete with subjective knowledge and subjective expectations. He argued that equilibrium could never be mathematically proven in a general or non-partial market. Those influenced by Lachmann imagine the economy as an open-ended evolutionary process of spontaneous order.

  1. Economic Equilibrium

    A condition or state in which economic forces are balanced. These ...
  2. Equilibrium

    The state in which market supply and demand balance each other ...
  3. Equilibrium Quantity

    Equilibrium quantity represents the amount of an item that is ...
  4. Radner Equilibrium

    A theory suggesting that if economic decision makers have unlimited ...
  5. Neoclassical Growth Theory

    The neoclassical growth theory is an economic concept where equilibrium ...
  6. Walras' Law

    Walras' law is a theory that the existence of excess supply in ...
Related Articles
  1. Investing

    Game Theory: Beyond the Basics

    Take your game theory knowledge to the next level by learning about the Nash Equilibrium.
  2. Investing

    Why You Can't Influence Gas Prices

    Don't believe the water-cooler talk. Big oil companies aren't to blame for high prices.
  3. Insights

    Fed's Fischer: Aging Population Suppressing Rates

    Federal Reserve Vice Chairman Stanley Fischer said the aging population and slow investment is keeping rates suppressed.
  4. Investing

    7 controversial investing theories

    Find out information about seven controversial investing theories that attempt to explain and influence the market as well as the actions of investors.
  5. Insights

    5 Nobel Prize-Winning Economic Theories You Should Know About

    Here are 5 prize-winning economic theories that you’ll want to be familiar with.
  6. Trading

    An Introduction To J-Charting

    Learn about a technical tool that's based on the view that markets are energetic systems.
  7. Investing

    Nobel Winners Are Economic Prizes

    Before you try to profit from their theories, you should learn about the creators themselves.
  8. Investing

    Modern Portfolio Theory Vs. Behavioral Finance

    Or: How financial markets would work in an ideal world vs. how they work in the real world.
  1. What does the Nash equilibrium predict?

    Learn more about the famous Nash equilibrium, which is the revolutionary concept in game theory about the economics of human ... Read Answer >>
  2. How Does the Law of Supply and Demand Affect Prices?

    Learn how the law of supply and demand affects prices. Read Answer >>
  3. What is the difference between a dominant strategy solution and a Nash equilibrium ...

    Dive into game theory and the Nash equilibrium, and learn why the Nash equilibrium assumptions about information are less ... Read Answer >>
  4. Why are there no profits in a perfectly competitive market?

    See why economic profits are theoretically impossible in a perfectly competitive market and why some economists use perfect ... Read Answer >>
  5. How do externalities affect equilibrium and create market failure?

    Discover the ways that externalities lead to market failure. Externalities are costs or benefits that go to a third party, ... Read Answer >>
  6. Why is game theory useful in business?

    Once hailed as a revolutionary interdisciplinary phenomenon, game theory is actually applicable in today's business world. ... Read Answer >>
Hot Definitions
  1. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  2. Entrepreneur

    An Entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture. ...
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  5. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  6. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
Trading Center