2
$\begingroup$

Two alternative approaches to compute a market equilibrium (in static analysis) are either to minimize the differences (either using abs() or a quadratic diff) between supply-demand quantities and prices in a given market or maximise the total surplus.

Which are the advantages of these two approaches and when to prefer one over the other?

I noticed that many partial equilibrium models (e.g. 1, 2 (p 42)) use the max surplus method, but I wonder why.

$\endgroup$
1
$\begingroup$

Market Equilibrium occurs when the difference between demand and supply is minimized. Equilibrium price and quantity is determined by solving this problem.

Surplus Maximization (or efficiency) is a property that we would want equilibrium to have. First Welfare Theorem says that in competitive markets (in the absence of externalities) market equilibrium is surplus maximizing. In standard demand-supply framework, solving for equilibrium and efficiency yields identical outcomes, and that is why these methods are used interchangeably.

$\endgroup$
  • 1
    $\begingroup$ Absolutely correct.. but it doesn't answer the question.. when (including eventually "technical" reasons) one approach is preferable over the other ? $\endgroup$ – Antonello Mar 7 '17 at 7:22
  • 1
    $\begingroup$ Surplus maximization is solving a single optimization problem at the social level whereas finding market equilibrium requires solving multiple optimization problems at the individual level. Solving a single problem can be helpful and saves a lot of time because many terms (like the ones that appears as revenue for some, and the cost for some) gets cancelled when aggregating the objectives. $\endgroup$ – Amit Mar 7 '17 at 8:21

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.