Positive and Normative Analysis

Equilibrium analysis

The importance of economic equilibrium in understanding and applying economic principles cannot be overstated. An equilibrium can be regarded as an artificial construct that allows one to examine the properties of the model in a situation where every agents’ choices and activities are consistent with each other and no agent would have an incentive to change its choices or activities.

Equilibrium and economic context. The equilibrium has to be defined relative to the economic environment. So if we make the environment more complicated within the economic model it should not come as a surprise that we need a more carefully specified definition of what an equilibrium state is. We can imagine this by analogy with a mechanical model: the more intricate the system of levers, wheels and pulleys, the more you add on extra subsystems, the more carefully you will need to specify the conditions for the whole contraption to be in balance.

The comparative statics method. How do things in the model change as things in the environment around it change? The comparative statics method provides a way of dealing with this issue. It is built on the concept of equilibrium and focuses on the relationship between the equilibrium itself and one or more key parameters. It is not a description of a process but is more like a set of snapshots of di¤erent instances of equilibrium that leave a trace of a process.

The comparative statics method is sometimes incorporated into specific relationships that are used as a shorthand to characterise the behaviour of an economic agent. The prime example of this is demand and supply functions collectively referred to as response functions.

We use the comparative statics method time and again to get some insight on here the economic machine might move if certain levers were pulled. How the machine moves from point to point requires an explicit model of dynamic processes.

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