DEFINITION of Walras' Law
Walras' law is an economic theory that the existence of excess supply in one market must be matched by excess demand in another market so that it balances out. Walras' law asserts that an examined market must be in equilibrium if all other markets are in equilibrium. Keynesian economics, by contrast, assumes that it is possible for just one market to be out of balance without a "matching" imbalance elsewhere.
BREAKING DOWN Walras' Law
Walras' law assumes that the invisible hand was at work to settle markets into equilibrium. Where there was excess demand the invisible hand would raise prices; where there was excess supply the hand would lower prices for consumers to drive markets into a state of balance. Producers, for their part, would respond rationally to changes in interest rates - if rates rose they would reduce production and if they fell they would invest more in manufacturing facilities. All these theoretical dynamics were predicated upon the assumptions that consumer pursue self-interests and firms try to maximize profits.
Critique of Walras' Law
Observations did not match theory in many cases. Even if "all other markets" were in equilibrium, an excess of supply or demand in an observed market meant that it was not in equilibrium. Economists who studied and built on Walras' law hypothesized that the challenge of quantifying units of so-called "utility," a subjective concept, made it difficult to formulate the law in mathematical equations, which Walras sought to do. Measuring utility for each individual, not to mention aggregating across a population to form a utility function, was not a practical exercise, critics of Walras' law argued, and if it could not be done, the law would not hold.
Who Was Léon Walras?
Walras' law is named after French economist Léon Walras (1834 - 1910), who created general equilibrium theory and founded the Lausanne School of economics. Walras' famous insights can be found in the book Elements of Pure Economics, published in 1874. Walras, along with William Jevons and Carl Menger, were considered founding fathers of neoclassical economics.