Week 6/7 - General equilibrium

Question 1

General equilibrium

Answer 1

Is generally the idea that a change in one market causes changes in another.

Question 2

Pure exchange economies

Answer 2

• 2 consumers and 2 goods
• No production, only exchange
• Consumers have an initial endowment (which acts as resource contraints) of
  goods (a bundle of the 2 goods) and try to
  maximise utility
• We represent preferences using a utility
  function and thus indifference curves
• For each good in the economy, there is a
  competitive market
• Will only accept trade if both are better off. That is their utility is higher at new bundle.

Question 3

Edgeworth Box

Answer 3

Represents differents agents preferences into one diagram.
It also takes into account resource contraints.
- Need to make both players better off.
- Are both better off in shaded green area. Where both would be on higher indifference curves relative to origin points.

Question 4

Pareto efficient

Answer 4

• Wellbeing of one actor must be comprimised in order to improve the well being of another.
• One person cannot be better off without the other being worse off.
• Therefore a pareto efficient allocation, if it is not possible to find another allocation whcih would improve one player without harming the other.
• Can BOTH players be made better off if they move? if the answer is NO then, it IS a pareto efficient allocation.
  e.g. point E would NOT be pareto efficient. Because there are allocation which would make both of them better off.
  e.g. point where indifference curves are tangental for both WOULD be a pareto efficient point.

Question 5

Contract curve

Answer 5

The set of Pareto Efficient allocations that can be achieved given the resource constraints (total endowment)
- the contract curve is the purple line joining the origin points

Question 6

The core

Answer 6

the set of Pareto Efficient allocations that can be achieved given the initial endowments (subset of the Contract Curve)
- the core is the green highlighted section of the contract curve.
- the core is different to the contrct curve, because it ensures that relative the intial endowment, both players are improving.
- this is where new endowments should be following trade, such as to make both players better off.

Question 7

Competitive equilibrium

Answer 7

• An equilibrium occurs when the demands of the agents are “compatible” (with the resource
  constraint)
• Produces pareto efficiency

Question 8

First Welfare theorem

Answer 8

• Any competitive equilibra is Pareto Efficient
  Assumes:
  -No Externalities - market failure, there are externalities
  -No Public goods
  -No Market Power not everyone is a price taker as we assumed.
• No Interdependencies
  -Perfect Information

Question 9

Second welfare theorem

Answer 9

• This can be seen as the inverse of the first
• The Second Theorem says that any efficient
  allocation can be a competitive equilibrium allocation, given a suitable redistribution of
  resources.
• For the Second Welfare Theorem to hold, we need preferences to be convex (not needed
  for the first)

Question 10

What makes allocation efficient and mutually beneficial

Answer 10

MRS of both individuals is equal.