5 - Walras and general equilibrium theory

Summary

Léon Walras wrote his most important work, Elements of Pure Economics or the Theory of Social Wealth (EPE, 1874), at around the same time as Jevons published Theory of Political Economy. At first sight, the theories of Jevons and Walras appear to be very similar. Jevons describes the process of exchange, which allows trading bodies to exchange commodities in order to maximize their utility; in equilibrium, the ratio of exchange between two goods will be equal to the relative valuations for both trading bodies. Walras calls this the “condition of maximum satisfaction”, and he recognizes that his analysis is very similar to that of Jevons. Moreover, Walras praises Jevons’s use of mathematics.

However, Walras’s work does not depart from Bentham’s theory of utilitarianism. More importantly, Walras goes beyond Jevons in his description of the entire economy. For Jevons, the process of exchange takes place between two trading bodies that are exchanging two goods. He does of course know that there are more than two trading bodies and more than two goods in modern markets, but his analysis remains restricted to this simple case. Walras, by contrast, aims to develop a mathematical model that describes the economy as a whole.

We saw in the previous chapter that every act of exchange alters the conditions of supply and demand, since after the exchange the trading bodies will hold more or less of each commodity. This will in turn affect their relative valuations, and therefore the ratio of exchange or the market price. However, a different price for one good may also have implications for another. For instance, we all know that the price of airline flights tends to increase when the price of oil goes up. This is obvious, because oil is an important input for the airline flight industry. But even goods that do not seem to be interconnected may influence each other. For instance, housing is usually a large share of the budget of any consumer. When the price of housing increases, consumers may then have to cut their spending on nearly all other goods.