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

WHEN PARTIAL EQUILIBRIUM ANALYSIS
WILL DO
In the examples of the widening wage gap and the price of oil, general equilibrium
analysis is clearly important. But can we ever focus on what goes on in a single
market, without worrying about the reverberations in the rest of the economy? Are
there circumstances in which partial equilibrium analysis will provide a fairly accurate
answer to the effect of, say, a change in a tax? When will the sort of analysis
we used earlier in this chapter to analyze the impact of a tax on cigarettes and
cheddar cheese be sufficiently accurate?
Partial equilibrium analysis is adequate, for example, when the reverberations
from the initial imposition of a tax are so dispersed that they can be ignored without
distorting the analysis. Such is the case when individuals shift their demand
away from the taxed good toward many, many other goods. Each of the prices of
those goods changes only a very little. And the total demand for the factors of
production (such as capital and labor) changes only negligibly, so that the
second-round changes in the prices of different goods and inputs have a very slight
effect on the demand and supply curve of the industry analyzed. In these circumstances,
partial equilibrium analysis will provide a good approximation of what
will actually happen.
Our earlier analysis of a tax on cigarettes is an example of partial equilibrium
analysis providing a good approximation. Since expenditures on cigarettes are a
small proportion of anyone’s income, an increase in their price will have a small effect
on overall consumption patterns. While the reduced quantity demanded of cigarettes
(and the indirect changed demand for other goods) will slightly change the total
demand for labor, this effect is so small that it will have no noticeable impact on the
wage rate. Similarly, the tax will have virtually no effect on the return to capital.
Under these circumstances, when more distant general equilibrium effects are
likely to be so faint as to be indiscernible, a partial equilibrium analysis of a tax on
cigarettes is appropriate.
Looking Beyond the Basic Model
This chapter has brought together the pieces of the basic competitive model. It has
shown how the competitive equilibrium in an ideal economy is achieved. To the
extent that conditions in the real world match the assumptions of the basic competitive
model, there will be economic efficiency. Governments will have little role
in the economy beyond establishing a legal framework within which to enforce
market transactions.
What are the consequences when the underlying assumptions are not valid?
Which of the assumptions are most suspect? What evidence do we have to assess
either the validity of the model’s underlying assumptions or its implications? The
next part of this book is devoted to these questions, and to the role of government
that emerges from the answers.
234 ∂ CHAPTER 10 THE EFFICIENCY OF COMPETITIVE MARKETS