Topic 6: General Equilibrium in an Exchange Economy

Question 1

tradeoff we face with models

Answer 1

how much detail/realistic complications to include in the model vs. how broadly applicable the story is

Question 2

issue with the general equilibrium model

Answer 2

has huge scope so we sacrifice a lot of detail

looks at the interaction of all markets at once: supply and demand of all things together, as two sides of the same coin

Question 3

edgeworth box

Answer 3

allocations and distribution of goods between A and B

Question 4

indifference map

Answer 4

each person’s preferences is only what is in their own bundle

not true in reality but in the model, utility function only depends on the amount of good 1 and good 2 and individual have

Question 5

pareto efficient point

Answer 5

point from which no mutually beneficial trade exists
- no other allocation that both consumers prefer

situation where it’s not possible to do something better for everyone

Question 6

pareto improvement

Answer 6

better for at least one person and neither person likes it less

Question 7

competitive equilibrium

Answer 7

allocation of goods for each person

prices for each good

Question 8

conditions of competitive equilibrium

Answer 8

each consumer’s allocation is utility-maximising for them given specific prices

market for each good must clear

Question 9

issue with auctioneer

Answer 9

not a realistic institution so formation of prices is mysterious

Question 10

how can the model fail to apply?

Answer 10

competitive equilibrium doesn’t exist even in an abstract model

Question 11

FTWE

Answer 11

preferences are locally satiated

market exists for all commodities (no externalities)

all markets are competitive with prices publicly known

then, every general equilibrium involves a pareto efficient allocation

Question 12

FTWE as a roadmap for microeconomic policy

Answer 12

more to the world than pareto efficiency

if we want pareto efficient allocations, this condition tells us equilibrium

Question 13

list of conditions rendering FTWE not applicable

Answer 13

some agents not being price-takers

no market for some goods

markets in disequilibrium

Question 14

STWE

Answer 14

all consumers have convex preferences

all firms have convex production possibility sets

any pareto efficient allocation can be achieved as the equilibrium of a complete set of competitive markets, given suitable reallocation of the endowment

Question 15

interpreting STWE

Answer 15

escape route from the criticism that pareto efficiency is too weak?

transferring endowment is impossible
- time, ability, knowledge, etc.

transferring income is not the same thing
- product of an agent’s decisions and not the endowment they start with

different interpretation: prices should be reserved as allocative signals but not to achieve distributional goals

Question 16

issue with pareto efficiency

Answer 16

doesn’t concern fairness or equity

Question 17

equitable allocation

Answer 17

no agent prefers any other’s bundle over their own

Question 18

fair allocation

Answer 18

both equitable and pareto efficient