Partial equilibrium

Partial equilibrium is a concept of economic equilibrium, widely used in microeconomics, which focuses on the study of a company, particular market or economic sector assuming that the situation in the rest of the system is constant, especially the prices of substitute goods and supplements, income levels of consumers, etc.

In other words, partial equilibrium analysis proposes that the sale of what a certain firm or type of firms produces—all goods of a certain type available on the market—is independent of the situation for other goods or in other firms or markets. The basic paradigm is that prices adjust until supply equals demand. (see supply and demand)

The simplicity of the basic model inherent in the model—introduced by Alfred Marshall—makes the approximation easily understandable and manipulable. However, that very simplicity has the consequence of producing results that, despite appearing accurate, do not necessarily reflect real situations.

At a theoretical level, the model presents a simple but powerful technique for analyzing relationships that lead to Pareto optimal situations, establishing bases for static comparisons, etc.

The analysis also has the advantage of concentrating on the practical problem you face, be it a particular industry or business sector.

History

In order to study specific markets, Alfred Marshall introduced tools to analyze supply and demand. Central to that effort is the diagram of supply and demand . This diagram represents prices on the vertical axis and the quantity produced of a specific good on the horizontal axis. The line that goes back to the right represents the law of supply: the higher the price, the supply produces more goods. The line that decreases to the right represents the law of demand: demand falls with increasing prices.

The lines obviously intersect -producing what Marshall called the 'scissor' of output for that market. Marshall argued that competition would drive real prices to the point at which the lines intersect, which establishes the price or break-even point for that market. If producers demand more for their product, not everything produced will be sold. And on the contrary, if they charge less, the production will not satisfy the demand. Only at the equilibrium point will everything produced find buyers and be sold (the market will clear).

Introduction to analysis

As is obvious, Marshall bases his suggestion on the perception that both supply and demand determine prices . As is equally obvious, these factors do not have to remain stable in the medium or long term.

If the lines move together either to the right or to the left, we are in a situation in which the quantity produced increases or decreases without changing prices. If the lines move together up or down we are in a situation in which the quantity produced remains the same but prices increase (inflation) or decrease (deflation).

Relative changes can be seen as the lines moving to the right or left. If the demand line moves to the right (demand increases) or the supply line moves to the left (supply decreases), the equilibrium point (market prices) rises. And vice versa and jointly a balance is obtained.

The factors that control these movements are. A) from the point of view of consumers: variations in disposable income.- advertising, fashion and perceptions of the "quality" of the good.- availability of alternative goods.- variations or perceptions of future changes in supply. B) from the point of view of the producer: variations in the prices of inputs and resources.- variations in technology.- variations or perceptions of future variations in demand.

Elasticity

The foregoing suggests an obvious question: if production depends on prices or assuming that a rise in prices causes a decrease in demand and the establishment of a new equilibrium point, what will that point be? What factors affect the demand-price relationship when prices change?

The answer is given by the concept of elasticity, elasticity tells us how much demand changes when prices change. It can be conceived as determining the inclination or angle of the demand line: a vertical demand line would imply that, no matter the price, demand is maintained (the consumption of that good is of low elasticity), on the contrary, a line of demand approaching the horizontal implies that small changes in prices have large effects on demand (consumption is very elastic).

The factors that influence elasticity are similar to those of demand, with a couple of additions: the need and level of consumption. For some goods - for example salt - the price in relation to total spending is such that an increase in price does not affect consumption greatly, the extra spending is trivial. Other goods -for example, drinking water- have consumption levels that are not easily modifiable, or even cannot fall below a certain level.

The concept of elasticity has a greater importance in economics than the mere explanation of the price-consumption relationship. Many economic phenomena of interest are established from similar non-direct cause-effect relationships, that is, related by a function: a= f (b,c...)

In this particular case, if we want to establish the elasticity, we need to establish how the quantity demanded varies in relation to price changes. That is, how d varies in relation to variations in p, or, mathematically: ∆ d/∆p.

In economics, elasticity is generally represented by the Greek letter epsilon (ε or E). From a mathematical point of view ε is a real number that predicts what percentage increase of a variable "Y" we will have if there is a percentage increase of a variable "X", which controls or partially determines the level of Y:

from where - in order to simplify the calculation: .

Short and long term

This raises an obvious question. For example, following the 1973 oil crisis, initial consumption did not change as much as expected. Consumers were not only used to using their cars in a certain way, but they were also “forced” to keep using them. Later purchases, however, began to show a preference for cheaper vehicles, and eventually automakers produced models that accommodated that predilection.

This implies that the conception of elasticity must incorporate a time element.

Marshall defines the market period as being the time required for a market to react to changes in prices. Any good produced before that period has elapsed will be produced at the former cost, whether or not it is profitable.

For example, a farmer can only react to changes in demand and/or prices over a period of months, perhaps a year. But regardless of what they cost in the present, the farmer will have to sell his produce at that price.

Periods shorter than the “market period” are considered short term (short run). In the short term, changes in demand will affect production only to a limited extent. Companies can, for example, make better use of their resources -assuming they are not already doing so- but employing more workers, increasing machinery or installed capacity, etc., takes time. On the contrary, companies generally produce on the basis of long-term calculations: reduce production, lay off employees, buy fewer supplies, etc. they are not decisions to be made lightly or quickly.

The long term (long run) is the period that allows companies to respond to these changes. The long term is the period in which companies can enter or exit a market in a planned manner.

Economic period and work

Marshall identifies a special type of market: the labor market. Unlike the others, in this market it is the households that make the supply/production, and the companies that make the demand.

Marshall postulated that the labor market actually consists of two independent sectors or markets.

The first works according to the Malthusian principle, which suggests that any increase in wages will lead to an increase in population, which will eventually lead to a fall in wages, according to the iron law of wages.

The second works or depends on technological change, which implies a demand for an educated workforce. Since the “production period” of this workforce is long, wages in this sector tend to be high.