Review Notes – General Equilibrium •
Two Conclusions from the Section Voluntary exchange is mutually beneficial Voluntary exchange results in efficiency
What are the benefits of exchange? Assumptions of the model • 2 consumers, 2 goods • initial endowments and MRS for both What is an Edgeworth Exchange Box? • Make sure you know how the box works – what is on each axis? How is each consumer’s consumption measured for each good? • How are preferences for each consumer shown? • How does the model demonstrate that voluntary trade is mutually beneficial? • What is the contract curve? • How does the contract curve show pareto efficiency (what’s that?) Exchange using markets in an Edgeworth Box Diagram • Both consumers choose their optimum consumption given endowments and market prices. • If either market is not in equilibrium, then new market prices occur until reach equilibrium • At equilibrium QD=QS for each good (i.e., neither excess demand or supply for either good). What do we know about exchange from the model? • First Theorem of Welfare Economics o All competitive market equilibriums are efficient (why?) • Second Theorem of Welfare Economics o All efficient outcomes (allocation of goods between consumers) can be achieved by appropriately changing market conditions What must be done to relative prices? What must be done to endowments (i.e., redistribution of income) • What are the implications of these two theorems?