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Unformatted text preview: Lecture 26: Exchange. c & 2008 Je/rey A. Miron Outline 1. Introduction 2. The Edgeworth Box 3. Trade 4. Pareto E¢ cient Allocations 5. Market Trade 6. The Algebra of Equilibrium 7. Walras Law 8. Relative Prices 9. Existence of Equilibrium 10. Equilibrium and E¢ ciency 11. The Algebra of E¢ ciency 12. E¢ ciency and Equilibrium 13. Implications of the First Welfare Theorem 14. Implications of the Second Welfare Theorem 15. Social DecisionMaking 1 1 Introduction We have so far focussed on modelling a market for a single good in isolation. We have a model of demand, of supply, and of equilibrium in a given market. For a great many questions, both positive and normative, these partial equilib rium models su¢ ce, even though we know that as a general rule they cannot be literally correct. Each partial equilibrium models takes as given the prices, wages, incomes, and so on determined outside that particular partial equilibrium. But, things that happen in this equilibrium spill over into other markets, and there can then be feedback from that other market to the market in which the original shock occurred. For example, an increase in the income of farmers ought to spill over into the market for tractors, and then the income of tractor producers is higher, so they purchase more food, raising the income of farmers. For some questions, these interactions between markets are important. Analysis of the economy overall is known as general equilibrium analysis. Macroeconomics is one kind of general equilibrium analysis. General equilibrium analysis is inherently more complicated than partial equi librium analysis, so we need to make simplifying assumptions to keep the analysis manageable. Some of these assumptions are critical to the results that follow, others innocuous; we will discuss the role of the assumptions as we go along. One key issue to keep in mind is that normative issues become far more important as we start to discuss general equilibrium. We have so far addressed some normative issues, such as whether policy should allow price discrimination by monopolists, but overall we have mainly emphasized positive analysis. Starting with this lecture, and continuing for the rest of the course, the normative issues will be much more important. We are not going to necessarily take a strong stand, but we will develop a framework that allows us to think about normative questions. 2 The Edgeworth Box So, we start with the simplifying assumptions: 2 1. We assume exactly two consumers; these might have di/erent preferences and endowments. 2. We assume competitive markets. All participants act as price takers even though the number of participants is small. This is an example of a modeling approach we have discussed before: assume a given agent acts as a price taker, to simplify the analysis, even though in the particular situation modeled that agent would want to exploit monopoly or monopsony power. This is a reasonable approach if, for example, the same conclusions would result in a model with a very large number...
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This note was uploaded on 09/16/2009 for the course ECONOMICS 1010A taught by Professor Jeffreya.miron during the Fall '09 term at Harvard.
 Fall '09
 JeffreyA.Miron

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