General Equilibrium Trade With Prices In Edgeworth Box

Question 1

Up to now we only considered trade by exchange, now we look at prices

Question 2

Trade with prices: agents and their actions

Answer 2

Auctioneer: sets prices of goods (p1 and p2)

People: A and B work out their wealth (value of endowments) and how much they would like to buy of good 1 and 2

Question 3

What does this look like graphically

Answer 3

Budget constraint is added, and endowment must be on the budget constraint line.

She also selects her optimal bundle given the budget constraints

Question 4

Budget constraint slope

Answer 4

-p1/p2

Question 5

Pg 85 - Visualising net demands for the 2 goods

Answer 5

We can see for their optimal bundle and the current endowment, they want less of good 1 and more of good 2.

Question 6

Pg 86 - add in person B’s net demands

Answer 6

So in this case,

A wants less good 1, more of good 2.
B wants more of good 1, less of good 2.

A wants to reduce their amount of good 1 by a higher amount than B wants to increase it, so…
Total demand for good 1 is less than supply.

A wants to increase their amount of good 1 more than the amount that B wants to reduce of good 1, and so
Total demand for good 2 is greater than supply

We can see market has not cleared as the net demands do not correspond. We are in disequilibrium

Question 7

What must happen?

Answer 7

Auctioneer must alter prices to clear market.

Question 8

What will auctioneer say prices to

Answer 8

Set prices to allow

Amount demanded by one person = amount other wants to sell

I.e net demands equal

Question 9

What does this market clearing price look like

Answer 9

Budget line goes through tangental IC’s

Question 10

What is a competitive/market/walrasian equilibrium?

Answer 10

The set of prices where each consumer chooses their most preferred affordable bundle, and demand=supply