Equilibrium in Economics April 4, 2013 at 8:19 pm

Noahpinion has an interesting post on the variety of equilibria in economics:

Walrasian equilibrium, also called “competitive equilibrium” or sometimes “general equilibrium”, is basically when prices adjust so that all markets clear…

A Nash equilibrium is when people’s strategies are best responses to each other – in other words, when no one would choose to change their plans if everyone else’s plans stayed fixed…

A Rational Expectations Equilibrium (REE) is a kind of Walrasian equilibrium with uncertainty about the future. In addition to the condition that prices adjust to clear markets, a REE includes the condition that people’s subjective beliefs about the probability of future events are equal to the actual probabilities of those future events.

What if prices can’t adjust to clear markets? … In that case, markets might not clear, so you wouldn’t have a Walrasian equilibrium. BUT, you’d still have people’s plans being consistent with each other. In this case, you’d have the kind of equilibrium in a sticky-price New Keynesian macro model, in which labor markets don’t always clear.

In most dynamic models (for example, DSGE models), the economy tends toward some “steady state”, in which either nothing in the economy is changing, or in which things are only changing at constant long-term trend rates.

What’s interesting, I think, is how rare these are in practice. You do get Walrasian equilibria in financial markets with price transparency, informed agents, and highly fungible goods. The others, though, are theoretically nice but in practice rare, not least because the forcing – external event – happens more frequently than the relaxation time (the time to get close to equilibria). And because agents aren’t rational, and don’t plan…

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