Walras's Law

Walras's law is a market equilibrium theory; the excess demand for a commodity in one market is offset by surplus supply witnessed in another market. Markets have a tendency to attain economic equilibrium.

This economic theory was proposed in 1874 by a French economist—Léon Walras. Walras published his theories in Elements of Pure Economics. Markets attain equilibrium when, at a particular price, the quantity demanded by consumers is completely fulfilled by supply.

• The Walras law is a macroeconomic outlook of demand and supply; markets have a tendency to attain economic equilibrium. Walras claims that when one market has excess demand, another market shows equivalent supply surplus to offset it.
• This market tendency resembles the invisible hand concept—as if an invisible hand controls market demand and supply.
• Excess demand leads to a price rise. Similarly, surplus supply triggers a fall in goods prices.
• Walras's law has been proven wrong in many practical scenarios. In many market scenarios, all the markets attained equilibrium, but still, a particular market experienced surplus demand or supply, causing a disbalance.

Walras's law states that markets have a tendency to attain overall economic equilibrium—as if there is an invisible hand steering excess supply towards falling prices and surplus demand towards a rise in prices.

Léon Walras was a French economist. He was the founder of the Lausanne School of Economics. Walras published Elements of Pure Economics in 1874.

Businesses always look for ways that can increase profits. Similarly, customers look for sources that can fulfill personal needs. Thus, if interest rates are increased, producers will lower production and vice versa. This way, the demand and supply of goods and services get influenced. High demand triggers a price rise, and plummeting demand brings down commodity prices.

Walras’s law is represented by the following equation.

 zi = xi – yi – wi 

• Here, zi denotes excess goods demand,
• i denotes the goods.
• xi is goods demand.
• yi is the sum of supply from two firms.
• wi is the initial endowment. (Quantity of goods with the customer, before the trade)

The following implications highlight the significance of Walras’s Law.

1. According to Walras's law, markets attain equilibrium when, at a particular price, the quantity demanded by consumers is completely fulfilled by supply.
2. This law believes that markets are in general equilibrium when different world economies are in partial equilibrium.
3. It works on the invisible hand principle—it facilitates market equilibrium. When the market foresees surplus supply, commodity prices fall. Similarly, when there is excess demand, prices rise.
4. It also indicates that the sum of surplus demand in different markets is always zero, irrespective of the General Equilibrium. As a result, when the demand in one market has a positive surplus, the demand in another market will have a negative surplus.

If there are two goods x and y in an economy, the surplus demand for the goods x will always be balanced against the excess supply of goods y. But Walras's law doesn't always stand true in the practical world. The law claims the aggregate of excess demand in different markets should be zero, but this concept doesn't fit the equilibrium theory.

Let us look at another example:

Let us assume that an economy has two commodity markets: coffee and tea. According to Walras's law, if there is excess demand in the coffee market, then there will be surplus supply in the tea market.

This can be partially true for substitute goods in the short run since the demand of coffee buyers is not completely met. A fraction of coffee buyers might start consuming tea. However, since demand and supply are directly related, coffee producers can simply increase their supply—to meet surplus demand.

Let us look at one more example. Tom opens a small eatery offering sandwiches, hotdogs, hamburgers, fries, and shakes. After a month of operation, Tom receives a good response.

Every day Tom sells:

• 50 Shakes
• 45 sandwiches
• 60 hamburgers
• 30 Fries
• 120 Hotdogs

By word-of-mouth, Tom earns a reputation for serving the best hotdogs—drawing in people from around the city. Soon, Tom faces a demand surplus—he has reached his production capacity but still can't meet the quantity demanded.

Before, instead of Tom, consumers visited Sally's—in the same neighborhood. So, according to Walras's Law, a surplus demand in Tom's eatery will coincide with a surplus supply at Sally's.

Although Walras was known as one of the finest economists, Walras's law was subject to many questions:

• While every market functions individually, Walras's law considers the whole market for the study.
• Although Leon Walras was renowned for his mathematical reasoning of economic concepts, his theory cannot be proved mathematically,
• Goods demand depends on utility. This law requires the aggregation of individual utilities to determine the population utility. But measuring an individual utility is impractical.
• Moreover, Walras's law has been proven wrong in many practical scenarios. It has been noted that even when all the other markets are at equilibrium, a particular market experiences surplus demand or supply, causing a disbalance.

This has been a guide to what is Walras's Law & meaning. We discuss how Walras's law works along with the definition, proof, examples, economic equilibrium, demand, supply, & limitations. You can learn more about it from the following articles -

• Classical Economics
• Environmental Economics
• Supply-Side Economics