Chapter 17 - General Equilibirum Flashcards
Edgeworth Box
Analyses the general equilibrium of an exchange economy:
2 consumers, 2 goods
- consumers endowed with an initial allocation of goods
- allowed to trade with each other to change their final allocation
Pareto-optimal condition
This is when it is impossible to make another person better off without making another worse off
Optimality is when MRS is same for both people
MRS (a) = MRS (b)
Pareto Superior
Allocation that at least one individual prefers and others like at least as well
(shaded area in Wedgeworth box)
Contract Curve (definition)
All efficient ways of dividing the 2 goods between the 2 consumers
- curve in edgeworth box depicting all Pareto optimal allocations
Marginal Rate of substitution
MUx/MUy
slope = -Px/Py
Initial and Total Endowments
Initial Endowments: (WaY, WaX) and (WbY, WaX)
Total Endowments: WY = WaY + WbY and WX = WaX +WbX
Marginal Rate of Transformation
Ratio of marginal cost (this is the slope of the PPF)
- MC(x)/MC(y)
Mcx = the foregone production of y given the MP of the resource
- taken from y to make more of x
Pareto EFFICIENCY
When MRS = MRT
MRS = MU(x)/MU(y) = Px/Py
MRT = MC(x)/MC(y) = Px/Py
Prices reflect both the marginal costs of production and the marginal benefits of consumption
1st Fundamental Theorem of Welfare Economics
also known as invisible hand theorem
an equilibrium produced by competitive markets will exhaust all possible gains from exchange
i.e. the equilibrium in competitive markets = Pareto optimal
2nd Fundamental Theorem of Welfare Economics
States that: Any allocation on the CC can be sustained as a competitive equilibrium
- condition that IC’s are convex
- significance = issue of equity in distribution is logically separable from issue of efficiency in allocation
Stuart Mill: society can redistribute income with justice and rely on market forces to ensure that those incomes are spent to achieve the most good
Monopolist produces less x than competitive market
- changes to GE
Resources shifted to produce y, too much y and too little x
Monopolist:
- Px > MC x
- MRT yx = Mcx/MCy < Px/Py
- consumers still set price ratio to MRS
- improve efficiency through shifting resources to X
Taxes in GE
Immediate affect of tax is to raise relative price ratio
Px/Py to Px/Py(1-t)
- e.g. tax on good y, producers produce more x than y instead
- causes inefficiencies as producers see a different price ratio (appears too cheap to a producer)
Head tax = Levied on each person based on their labour supply decisions
When is the PPF not concave?
This can occur when all sectors have constant RTS - resulting in a straight line for PPF
- also when there are IRTS, isoquants of production are getting closer and closer together as increasing inputs leads to an even greater than proportional increase in output
When both sectors = IRTS
- if there is little production of x, then cut in production = large amounts of resources, and increase production of y by a large amount
- if there is large production of x then the cut in its production doesn’t release large amounts of resources
Difference between PPF and contract curve?
They both measure the Pareto efficient allocations of production!
- however CC measures inputs on the axes and PPF measures output on the axes
When are allocations feasible (within an Edgeworth Box)
Allocations are feasible within the dimensions of the Edgeworth box…
- Dimensions of the box = quantities of available goods
- all allocations inside box also require that expressions hold equality! so allocations are non-wasteful
