[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

households determine their saving, which in turn determines the available supply of
capital. The supply of capital is affected, in general, by the return it yields (the interest
rate r) plus the income individuals have from other sources, in particular from
wages. Since the amount individuals are willing to save may depend on how welloff
they feel, and how well-off they feel depends on the wage rate relative to prices,
we can think of the supply of capital, too, as depending on wages, interest rates, and
prices. In Chapter 9 we learned how to derive firms’ demand for capital. This depends
not just on the interest they must pay but also on the price at which goods can be sold,
and on the cost of other inputs such as labor.
Equilibrium in the capital market occurs at the point at which the demand and
supply for capital are equal. Again, partial equilibrium analysis of the capital market
focuses on the return to capital, r, at which the demand and supply of capital are equal,
but both the demand and supply depend on the wage rate and the price of goods as well.
Finally, there is the market for goods. Chapter 5 showed how to derive households’
demand for goods. We can think of the household at first deciding on how much
to spend and then deciding how to allocate what it spends over different goods. Of
course, with a single consumption good, the second choice does not exist. In our simplified
model, then, we can think of the demand for goods at any price as being determined
by household income, which in turn depends on the wage and the interest rate.
Similarly, in Chapter 7, we analyzed how firms determine how much to produce.
They set price equal to marginal cost, where marginal cost depends on wages and
the interest rate. Equilibrium in the goods market requires that the demand for
goods equal the supply of goods. Again, while in the simple partial equilibrium analysis
we focus on how the demand and supply of goods depend on price, p, we know that
the demand and supply of goods also depend on both the wage rate and the return
to capital.
The labor market is said to be in equilibrium when the demand for labor equals
the supply. The product market is in equilibrium when the demand for goods
equals the supply. The capital market is in equilibrium when the demand for capital
equals the supply. The economy as a whole is in equilibrium only when all markets
clear simultaneously (demand equals supply in all markets). The general
equilibrium for our simple economy occurs at a wage rate, w; price, p; and interest
rate, r, at which all three markets are in equilibrium.
In the basic equilibrium model, there is only a single good, but it is easy to extend
the analysis to the more realistic case where there are many goods. The same web of
interconnections exists between different goods and between different goods and different
inputs. Recall from Chapter 3 that the demand curve depicts the quantity of a
good—for instance, soda—demanded at each price; the supply curve shows the quantity
of a good that firms supply at each price. But the demand curve for soda depends
on the prices of other goods and the income levels of different consumers; similarly, the
supply curve for soda depends on the prices of inputs, including the wage rate, the
interest rate, and the price of sugar and other ingredients. Those prices, in turn,
depend on supply and demand in their respective markets. The general equilibrium
of the economy requires finding the prices for each good and for each input such that
the demand for each good equals the supply, and the demand for each input equals
the supply. General equilibrium entails prices, wages, and returns to capital that ensure all
markets for goods, labor, and capital (and other factors of production) clear.
GENERAL EQUILIBRIUM ANALYSIS ∂ 229