Edgeworth Box

Question 1

What does general equilibrium analysis allow us to do?

Answer 1

We now view the economy as a system of related markets, with spillover effects.

GE analysis allows us to see the interactions of demand and supply in several markets to determine the market prices of several goods.

It endogenises prices and incomes.

Question 2

Edgeworth Box Characteristics

Answer 2

• 2 consumers and 2 goods.
• No production, only exchange.
• Consumers have an initial endowment.
• We represent preferences using a utility function and thus indifferent curves.
• Utility maximisation is the goal.
• Dimensions are the amount of the two goods.

Question 3

Indifference curves

Answer 3

IC curves intersect at the original endowment point, and the lens-shaped area between the two points indicates that there are more mutually beneficial trades to take place.

Two consumers will trade until their indifference curves will be tangential.

Tangency point is where consumers have equal MRS.

This is Pareto optimal/efficient, as you cannot make yourself better off without making the other trader worse off.

Question 4

Contract Curve

Answer 4

Shows us what Pareto optimal point the two consumers will arrive at. Every point along the contract curve is Pareto efficient. Joins up all the points where the indifference curves are tangential to each other.

Goes through both the origins, as one person having nothing and the other having everything is Pareto efficient.

Question 5

What is the core?

Answer 5

The lens-shaped area between the two indifference curves and along the contract curve. In the core, this is where the two consumers will undertake mutually beneficial trades.

Consumers would not agree to a point outside of the core, as this would not be mutually beneficial.