3.1 T2: Edgeworth box Flashcards
What is meant by pure exchange?
Assumption that goods are attained exogenously, then traded
See and learn
Edgeworth box set up page 1 my notes learn how to draw it
What does an EWB allow us to do?
Analyse the exchange of goods between 2 people
What are endowments?
Goods the economy starts with
What is an allocation? What makes it feasible?
Pair of consumption bundles. Feasible if there’s enough good to fulfill it
If there is a lens in the EWB what does this mean?
Both players can increase their own utility by trading and moving into the lens -> Pareto improvement
Trading continues until lens is eliminated, and the two ICs will be tangent to each other
See
Slide 28 ‘definitions of pareto efficient allocations)
What is a contract curve? Draw it.
Also known as a Pareto set, it is the line joining all the PEAs. It goes into the origins of both players
See
Market trade in EWB (w. prices) side 2 page 1 my notes, learn diagram
Where must the budget constraint go through?
The endowment point
Define gross demand?
How much of each good a person wants
Difference between gross demand and endorsement?
Net demand
What is the role of the auctioneer? and people?
Sets prices
People then calculate their wealth then work out how much to trade
What does changing the prices do?
It pivots the budget constraint around the endowment until it is tangent to the ICs of A&B at the same point
How do we know in equilibrium, the solution is Pareto efficient?
It lies on the contract curve
Define Walrasian equilibrium?
(/market/competitive eq.):
Set of prices such that each consumer is choosing the most preferred affordable bundle, and D=S in all markets
3 sufficient conditions for equilibrium in EWB?
1) total D = total S
2) Sum of net demand for each agent should =0 for each good
3) In equilibrium, aggregate net demand =0
If any of these 3 points hold you have found an equilibrium
See bottom of page 1 side 2
What is Walras’ Law?
For any set of prices (p1,p2) it is true that p1z1+p2z2=0
See notes!!!
See
Example CD utility functions
How to find the relative prices of 2 good that clear the market?
See notes (key point: must set one of the prices=1)
Scaling up, how can we be sure there is actually an equilibrium?
As long as aggregate net demand is continuous, we will be able to find an equilibrium - this is still true if many consumers!
Is this equilibrium always Pareto efficient, or are gains-to-trade available?
All market equilibria are Pareto Efficient (First theorem of welfare economics)
Is a Pareto efficient allocation always a market equilibrium?
No - if preferences aren’t convex then not necessarily (see diagram in notes)
BUT if preferences are convex, then any PEA is achievable as market outcome since a set of prices can be found such that slopes of ICs=slope of BC at tangency (STofWE)
What is the Second Theorem of Welfare Economics?
If all agents have convex preferences, there will be a set of prices such that each PEA is a ME, given appropriate endowments (must begin somewhere on BC
3 ‘strong’ assumptions of Welfare Economics?
Relies on strong assumptions: -agents only act in self interest -market operates efficiently -no externalities ALSO PEA is not the same as being 'fair' necessarily
2 uses of STofWE?
Policies can target endowments (lump sum taxes) to get to the appropriate endowment point
Policies can target goods (price taxes) to reflect scarcity of different goods
