3.1 T2: Edgeworth box

Question 1

What is meant by pure exchange?

Answer 1

Assumption that goods are attained exogenously, then traded

Question 2

See and learn

Answer 2

Edgeworth box set up page 1 my notes learn how to draw it

Question 3

What does an EWB allow us to do?

Answer 3

Analyse the exchange of goods between 2 people

Question 4

What are endowments?

Answer 4

Goods the economy starts with

Question 5

What is an allocation? What makes it feasible?

Answer 5

Pair of consumption bundles. Feasible if there’s enough good to fulfill it

Question 6

If there is a lens in the EWB what does this mean?

Answer 6

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

Question 7

See

Answer 7

Slide 28 ‘definitions of pareto efficient allocations)

Question 8

What is a contract curve? Draw it.

Answer 8

Also known as a Pareto set, it is the line joining all the PEAs. It goes into the origins of both players

Question 9

See

Answer 9

Market trade in EWB (w. prices) side 2 page 1 my notes, learn diagram

Question 10

Where must the budget constraint go through?

Answer 10

The endowment point

Question 11

Define gross demand?

Answer 11

How much of each good a person wants

Question 12

Difference between gross demand and endorsement?

Answer 12

Net demand

Question 13

What is the role of the auctioneer? and people?

Answer 13

Sets prices

People then calculate their wealth then work out how much to trade

Question 14

What does changing the prices do?

Answer 14

It pivots the budget constraint around the endowment until it is tangent to the ICs of A&B at the same point

Question 15

How do we know in equilibrium, the solution is Pareto efficient?

Answer 15

It lies on the contract curve

Question 16

Define Walrasian equilibrium?

Answer 16

(/market/competitive eq.):

Set of prices such that each consumer is choosing the most preferred affordable bundle, and D=S in all markets

Question 17

3 sufficient conditions for equilibrium in EWB?

Answer 17

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

Question 18

What is Walras’ Law?

Answer 18

For any set of prices (p1,p2) it is true that p1z1+p2z2=0

See notes!!!

Question 19

See

Answer 19

Example CD utility functions

Question 20

How to find the relative prices of 2 good that clear the market?

Answer 20

See notes (key point: must set one of the prices=1)

Question 21

Scaling up, how can we be sure there is actually an equilibrium?

Answer 21

As long as aggregate net demand is continuous, we will be able to find an equilibrium - this is still true if many consumers!

Question 22

Is this equilibrium always Pareto efficient, or are gains-to-trade available?

Answer 22

All market equilibria are Pareto Efficient (First theorem of welfare economics)

Question 23

Is a Pareto efficient allocation always a market equilibrium?

Answer 23

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)

Question 24

What is the Second Theorem of Welfare Economics?

Answer 24

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

Question 25

3 ‘strong’ assumptions of Welfare Economics?

Answer 25

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

Question 26

2 uses of STofWE?

Answer 26

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