WEEK 4 AND 5 - General Equilibrium

Question 1

What does a general equilibrium refer to?

Answer 1

A situation where markets clear simultaneously

• What goes on in 1 market, affects other markets
• Set of prices that clear all markets at same time

Question 2

What will a perfectly competitive market general equilbrium be?

Answer 2

Will be pareto optimal

Question 3

What is Pareto Optimality?

Answer 3

Where a given allocation of resources is not possible to make one person better off without making another
person worse off

Question 4

What is Pareto Improvement?

Answer 4

Where a given allocation of resources it is possible to make one person made better off without making
another worse off

At a Pareto optimal allocation of resources, there are no Pareto improvements to be made

Question 5

How do we start the model of a general equilbrium?

Answer 5

• Usually start with simplest case: Single market
• Pure exchange economy - 2 people (A and B) and 2 goods (1 and 2)
• Price (p): No of units of 1 people will swap for 2
• Goods are not produced but endowed (at a fixed rate) = ET1 and ET2 -> Total Endowments available

Question 6

What is one of the important elements of the model?

Answer 6

Determine P1 = 1 and all other prices are swap ratios (Pg many units of good g swapped for 1 unit of good)

• One of the goods is a numerraire

Question 7

What are the sums of individual endowment?

Answer 7

ET1 = EA1 + EB1  i.e A's apples + B's apples
ET2 = EA2 + EB2 i.e B's banana's + A's banana's

Question 8

When does the Market clear?

Answer 8

Clears when total demand equal to Total Endowments
(Demand = Supply)

Price clears these markets

Question 9

How do you identify the market for good 1?

Answer 9

DA1 + DB1 = EA1 + EB1

Question 10

How do you identify the market for Good 2?

Answer 10

DA2 + DB2 = EA2 + EB2

Question 11

What does an Edgeworth Box illustrate?

Answer 11

Illustrates how resources are divided in economy

SEE GRAPH IN NOTES

Question 12

How do we use an Edgeworth Box for final demand?

Answer 12

SEE GRAPH IN NOTES

Question 13

What does an Edgeworth Box with Indifference curves and budget lines? (Consumer A and B)

Answer 13

SEE GRAPH IN NOTES

Question 14

What is a Contract Curve?

Answer 14

Links every possible competitive outcome
- Links all pareto efficient points

SEE GRAPH IN NOTES

Question 15

Why is every point on a Contract Curve pareto efficient?

Answer 15

Can improve B’s utility without making A worse off (before reaching D)

Any further than D (point of tangency) become pareto optimal

Question 16

What does Arrow and Debreau say Pareto Optimality requires?

Answer 16

Pareto Optimal requires complete set of contingent future markets
(Infinite Number of Markets)

Question 17

What does Leijon Hupund state?

Answer 17

Trading must not take place til the market clears

- Non- Tatonnement

Question 18

What is the Core?

Answer 18

Section of contract curve which gives both consumers higher utility than initial endowment (point e)