comm402 Notes 3/31/10 Internal Exchange: formal model o o o 1) Consumer has set of preferences and knows them. I.e., can choose 2) Preferences are transitive. A>B>C so A>C 3) More of something will always be preferred to less of it
Internal exchange: formal model o Already can see an impossible indifference curve. Pg 198 It implies that less of both goods is equivalent in utility to more of them Its curve is an arc from lower left to upper right
Internal exchange: formal model o Oddly shaped (legal) indifference curves. P. 199 Concave curve (u2) belly is toward upper right of graph Produces corner solutions monogamy behavior
Straight lines (u3) generate either corner solution or no unique solution at all (e.g. if budget line is right on top of it)
Internal exchange: formal model o 4) indifference curves must be convex o Ie, belly points toward the origin
This assumption added because authors prefer not to mess with the odd shapes
Internal exchange: formal model o o o Can two indifference curves intersect? No. this would require violations of transivity and more is better assumption P. 201
Drawing indifference curves
o o
Can obtain actual indifference curves empirically but generally dont need to Any set of belly down non-intersecting will curves permit good thinking to be done.
External exchange o o Up to this point, whole chapter has been about internal exchange External exchange trade with another person
Edgeworth box o o Assume two people who divide all of the two possible commodities between them Draw indifference maps for each person separately
Edgeworth box o o o Take one of the indifference maps
Edgeworth box o o o Each person begins with some quantities each of the two commodities Locate that point in the edgeworth space This point will be on exactly one indifference curve for each person Their indifference curves will intersect at that point
Edge worth box o Between those two indifferences curves is a shaded area p. 205 Both people are better off (than at the start) if they more to any point in the shaded area Stare at the graph until you get it. Remember that one of the people is upside down
Edge worth & pareto points o o Since trading is voluntary no one will take a trade that harms self Trading will continue so long as at least one person is benefiting
o o o
Trading stops immediately when one person cannot get any additional utility This does not solve the problem of people starting with different resources Pareto point: cant move away without hurting someone