Chapter 18: Exchange Flashcards
A partial equilibrium analysis
A partial equilibrium analysis studies the determination of price and output in
a single market, taking as given the prices in all other markets.
General equilibrium analysis
General equilibrium analysis: How demand and supply interact in several
markets to determine the prices of many goods.
Pareto improving allocation.
An allocation that improves the welfare of a consumer without reducing the welfare of another is a Pareto improving allocation.
Pareto set, or the contract curve.
The indifference curves of the two agents must be tangent at any Pareto efficient allocation in the interior of the box.
The set of all Pareto efficient points in the Edgeworth box is known as the
Pareto set, or the contract curve.
trading process
If we have a particular trading process, we will have a more precise description of equilibrium. Let’s try to describe a trading process that mimics the outcome of a competitive market:
- Each consumer is a price-taker trying to maximize her own utility given p1, p2 and her own endowment.
The gross demand
The gross demand of agent A for good 1 is the total amount of good 1 that
he wants at the going prices.
net or excess demand
The net or excess demand of agent A for good 1 is the difference between
this total demand and the initial endowment of good 1 that agent A holds.
disequilibrium.
For arbitrary prices (p1, p2) there is no guarantee that supply will equal demand
(Figure 4). The market can be in disequilibrium.
A market is in equilibrium when …
A market is in equilibrium when the total amount that each person wants to
buy of each good at the current prices is equal to the total amount available.
This is called a market equilibrium, competitive equilibrium, Walrasian
equilibrium.
Walras’ law
Walras’ law states that the value of aggregate excess demand is identically
zero for any positive prices (p1, p2), whether these are equilibrium prices or not.
First fundamental theorem of welfare economics:
An equilibrium achieved by a set of competitive markets will be Pareto efficient.
a private market, with each agent seeking to maximize his own utility, will result in a Pareto efficient allocation.
Second theorem of welfare economics:
Second theorem of welfare economics:
If all agents have convex indifference curves, then there will always be a set of
prices such that each Pareto efficient allocation is a market equilibrium for an
appropriate assignment of endowments.
any Pareto-optimal allocation (i.e.
any point on the contract curve) can be achieved by trading in competitive
markets provided that endowments are first appropriately rearranged amongst
the consumers.
The Edgeworth box
shows all possible allocations of the available quantities of goods 1 and 2 between the two consumers.
it allows us to depict the possible consumption bundles for both consumers—the feasible allocations—and the preferences of both consumers.
A Pareto efficient allocation can be described as an allocation where:
- There is no way to make all the people better off; or
- there is no way to make some individual better off without making anyone else worse off; or
- all of the gains from trade have been exhausted; or
- there are no mutually advantageous trades to be made.
-> the marginal rates of substitution between the two goods must be the same.
The Lagrange function
is used to solve optimization problems in the field of economics. Lagrange’s method of multipliers is used to derive the local maxima and minima in a function subject to equality constraints.
