lecture 2

Question 1

what is The First Fundamental Welfare Theorem

Answer 1

the competitive market mechanism results in a Pareto-efficient allocation in all markets

Question 2

what conditions must be met for the Walrasian equilibrium to be present

Answer 2

the aggregate excess demand function should be a continuous function
This condition is satisfied if 1. Consumers have convex preferences, OR2. Consumers have discontinuous demand but are small relative to the size of the market (i.e. many small consumers - exactly what is needed for the assumption of competitive markets to be reasonable)

Question 3

how do you check if an allocation is PE

Answer 3

1. Find formulae for MRSA and MRSB
2. Substitute (XA ,YA) and (XB ,YB) into the formulae
3. If MRSA = MRSB then the allocation is Pareto efficient; if MRSA ≠ MRSB then the allocation is not Pareto efficient

Question 4

what is a perfect substitute

Answer 4

draw graph

Question 5

what are perfect complements

Answer 5

draw graph

Question 6

what does the contract curve show

Answer 6

The Contract Curve describes all PE allocations, where MRSA = MRSB

Question 7

what are the steps to finding the contract curve

Answer 7

1. Find MRSA and MRSB and set them equal to each other
2. Use the fact that XA + XB = total X and YA + YB = total Yto eliminate XB and YB
3. Solve for YA as a function of XA
4. Sketch in the Edgeworth box

Question 8

what to remember

Answer 8

1. If consumers have identical Cobb-Douglas or Logarithmic preferences, then the contract curve is the diagonal of the box
2. If both consumers have quasilinear preferences in Y, then the contract curve is a vertical line
3. If both consumers have quasilinear preferences in X, then the contract curve is a horizontal line