general equilibrium

Question 1

what are the two necessary conditions for pareto optimality?

Answer 1

feasibility - the outcome must make both individuals better off

pareto efficiency - can’t make a consumer better off without making 1 worse off; mathematically saying their slopes are identical

Question 2

how is pareto optimality visually represented?

Answer 2

start from a point on the edgeworth box; diminishing marginal utility so averages are preferred to extremes (the overlap of two opposing indifference curves is always better if the endowment doesn’t already start at the pareto optimal point)

the contract curve is where the slope of both ICs are identical i.e. one cannot be better off without the other being worse

Question 3

What is an arbitrage opportunity?

Answer 3

a profit opportunity that is riskless

Question 4

In defining an arbitrage opportunity, the key terms ‘opportunity’ and ‘riskless’ are mentioned. Elaborate on what those mean

Answer 4

1. opportunity means it is not always the case that one is guaranteed to profit

type 1: make money today
type 2: may make money tomorrow

2. riskless means that the investor never loses money i.e. the price is never more than 0