16.1 Beyond Partial Equilibrium

In the last chapter we analyzed partial equilibrium — that is, equilibrium in a single market, holding all factors outside that market constant.

But markets for one good don’t exist in a vacuum: the demand for one good is influenced by the prices of other goods, and the supply of one good depends on outside factors like the prices of inputs and, in the long run, the opportunity cost of switching industries. In this chapter we’ll show how we can use our models of consumer and firm behavior to move beyond the ceteris paribus assumption and start to model how a change in one market affects others.

We’ll start with the straightforward case of shifts in demand, by analyzing how changes in the price of one good affects the demand for (and therefore the equilibrium price and quantity of) other goods.

We’ll then analyze how an increase in price of one good indirectly affects the supply curve for other goods, by bidding up the price of inputs; and how the end result of this is a movement along the PPF.

Finally, we’ll use all of this to analyze the effect of a tax on one good on the market for other goods.