What is the 'General Equilibrium Theory'

General equilibrium theory, or Walrasian general equilibrium, attempts to explain the functioning of the macroeconomy as a whole, rather than as collections of individual market phenomena. The theory was first developed by the French economist Leon Walras in the late 19th century. It stands in contrast with partial equilibrium theory, or Marshellian partial equilibrium, which only analyzes specific markets or sectors.

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 — that is, 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 in aggregate.

Uses of General Equilibrium Theory

General equilibrium theory tried to show how and why all free markets tend 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 transactions 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’s 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. Competitive Equilibrium

    A competitive equilibrium is when profit-maximizing producers ...
  2. Equilibrium Quantity

    Equilibrium quantity represents the amount of an item that is ...
  3. Neoclassical Growth Theory

    The neoclassical growth theory is an economic concept where equilibrium ...
  4. Radner Equilibrium

    The Radner Equilibrium is a theory regarding economic decision ...
  5. Below Full Employment Equilibrium

    Below full employment equilibrium occurs when an economy's short-run ...
  6. Reflexivity

    Reflexivity is the theory that investors' perceptions affect ...
Related Articles
  1. Trading

    The Nash Equilibrium

    Nash Equilibrium is a key concept of game theory, which helps explain how people and groups approach complex decisions. Named after renowned mathematician John Nash, the idea of Nash Equilibrium ...
  2. Investing

    Seven 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.
  3. Insights

    Introduction to Supply and Demand

    Learn about one of the most fundamental concepts of economics - supply and demand - and how it relates to your daily purchases.
  4. Insights

    The Basics Of Game Theory

    Take an introductory look at game theory and the terms involved, and get familiar with backwards induction, a simple method for solving games.
  5. Trading

    An Introduction To J-Charting

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

    Effect of Fed Fund Rate Hikes on Oil

    Find out how oil markets might react to an interest rate hike by the Federal Reserve, and why consumers and bondholders could love a rising interest rate.
  7. Investing

    Oil As An Asset: Hotelling's Theory On Price

    Not sure where oil prices are headed? This theory provides some insight.
  8. Insights

    What is Supply & Demand?

    The law of supply and demand is one of the most basic principles in economics. In simplest terms, the law of supply and demand states that when an item is scarce, but many people want it, the ...
  1. What is general equilibrium theory in macroeconomics?

    Achieving equilibrium of prices in a single or multi-market setting involves a bidding process that is informed precisely ... Read Answer >>
  2. 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 equilibrium assumptions about information are less important ... Read Answer >>
  3. How does a monopoly contribute to market failure?

    Read a simple overview of the theory of market monopoly, where it originated and some contemporary challenges to the classical ... Read Answer >>
  4. 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 >>
  5. How is a market failure corrected?

    Find out how to think about market failures, how they tend to be corrected and different proposals about the best way to ... Read Answer >>
  6. How Does the Law of Supply and Demand Affect Prices?

    Learn how the law of supply and demand affects prices, as when one outweighs the other, prices can rise or fall in response. Read Answer >>
Trading Center