Production without consumption:

We have discussed the general equilibrium conditions in a pure exchange economy. We extend the analysis now to include production. While general approach to the problem similar to the one adopted in case of pure exchange economy, there are some differences we need  to account for. Particularly, we  cannot ensure  an equilibrium  if  the  production technology exists  in  large regions of increasing returns to  scale. As increasing returns to scale  implies  AC  exceeding  MC  , which means  that competitive firm will make negative profit.  

Consider, for example, an  increase in the price of some final good assuming a competitive  industry.  The inputs used  in  the process can  be  treated  as the initial endowments that are used to be transform in these goods. Such a feature requires us to see how market will allocate the following:

- production efficiency: how factors of production are used to produce goods;

- allocative efficiency: how much each consumer consumes of each goods; and

- product-mix efficiency: how total resources are allocated to each sector.

Moreover, each firm will try to expand  its output. Thus, factor price (of labor and capital) will change, as demand for these will go up at an aggregate level. In a closed  economy, the  production  of  the industry, which  produces a complementary good will also  be  affected. If resources can move from a substitute  good  producing industry,  then  the  effect  on  factor price will be determined by relative intensity of factor use  in each industry.