C H A P T E R 16 General Equilibrium and Economic Efficiency CHAPTER OUTLINE 16.1 General Equilibrium Analysis 595 16.2 Efficiency in Exchange 602 F or the most part, we have studied individual markets in isolation But markets are often interdependent: Conditions in one can affect prices and outputs in others either because one good is an input to the production of another good or because two goods are substitutes or complements In this chapter, we see how a general equilibrium analysis can be used to take these interrelationships into account We also expand the concept of economic efficiency that we introduced in Chapter 9, and we discuss the benefits of a competitive market economy To this, we first analyze economic efficiency, beginning with the exchange of goods among people or countries We then use this analysis of exchange to discuss whether the outcomes generated by an economy are equitable To the extent that these outcomes are deemed inequitable, government can help redistribute income We then go on to describe the conditions that an economy must satisfy if it is to produce and distribute goods efficiently We explain why a perfectly competitive market system satisfies those conditions We also show why free international trade can expand the production possibilities of a country and make its consumers better off Most markets, however, are not perfectly competitive, and many deviate substantially from that ideal In the final section of the chapter (as a preview to our detailed discussion of market failure in Chapters 17 and 18), we discuss some key reasons why markets may fail to work efficiently 16.1 General Equilibrium Analysis So far, our discussions of market behavior have been largely based on partial equilibrium analysis When determining the equilibrium prices and quantities in a market using partial equilibrium analysis, we presume that activity in one market has little or no effect on other markets For example, in Chapters and 9, we presumed that the wheat market was largely independent of the markets for related products, such as corn and soybeans 16.3 Equity and Efficiency 610 16.4 Efficiency in Production 613 16.5 The Gains from Free Trade 618 16.6 An Overview—The Efficiency of Competitive Markets 623 16.7 Why Markets Fail 625 LIST OF EXAMPLES 16.1 The Global Market for Ethanol 598 16.2 “Contagion” across Stock Markets around the World 600 16.3 Trading Tasks and iPod Production 621 16.4 The Costs and Benefits of Special Protection 622 16.5 Inefficiency in the Health Care System 626 595