General equilibrium theory

General equilibrium theory is the branch of neoclassical economics that attempts to prove that a market economy, left to itself, will settle into a state in which supply equals demand in all markets simultaneously. The Arrow-Debreu model, formulated in the 1950s, showed that under conditions of complete markets, convex preferences, and perfect information, such an equilibrium exists and is Pareto optimal. The theory is mathematically beautiful and empirically empty: its assumptions describe no economy that has ever existed, and its conclusions have never been successfully used to predict anything. General equilibrium is best understood not as a scientific model but as a formal demonstration of what would be true in a world without complexity.

The theory's central assumption — that prices adjust instantaneously to clear markets — ignores the very mechanisms that make economies interesting: information asymmetries, network effects, and the nonlinear dynamics of panic and contagion. When the 2008 crisis hit, no general equilibrium model predicted it because no general equilibrium model could predict it: the theory assumes away the financial frictions that produce crises.

General equilibrium theory persists not because it explains the economy but because it provides a mathematical foundation for policy conclusions that would be difficult to justify on empirical grounds alone. It is the grammar of a language in which laissez-faire is the only grammatically correct sentence.