# ch13 - Chapter 13 General Equilibrium and Welfare Perfectly...

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Chapter 13 General Equilibrium and Welfare

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Perfectly Competitive Price System We assume all markets are perfectly competitive a large number of homogeneous goods both consumption goods and factors of production each good has an equilibrium price there are no transaction or transportation costs individuals and firms have perfect information
Law of One Price A homogeneous good trades at the same price no matter who buys it or who sells it if one good traded at two different prices, demanders would rush to buy the good where it was cheaper and firms would try to sell their output where the price was higher these actions would tend to equalize the price of the good

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Assumptions of Perfect Competition A large number of people buying any one good each person takes all prices as given and seeks to maximize utility given his budget constraint a large number of firms producing each good each firm takes all prices as given and attempts to maximize profits
General Equilibrium For simplicity, we make the following assumptions There are only two goods (outputs), x and y There are only two inputs k and l that are used in producing x and y All individuals have identical preferences represented by an indifference map A production possibility curve can be used to show how outputs and inputs are related

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Edgeworth Box Diagram Construction of the production possibility curve for x and y starts with the assumption that the amounts of k and l are fixed An Edgeworth box shows every possible way the existing k and l might be used to produce x and y any point in the box represents a fully employed allocation of the available resources to x and y
Edgeworth Box Diagram y Total Labor Total Capital A Capital for x Capital for y Labor for y Labor for x Capital in y production Capital in x production Labor in y production Labor in x production

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Edgeworth Box Diagram Many allocations in the Edgeworth box are inefficient Can feasibly produce more x and more y Efficient input choices in competitive markets We want to find the efficient allocations they illustrate the actual production outcomes We use isoquant maps for the two goods – the isoquant map for good x uses O x as the origin – the isoquant map for good y uses O y as the origin Efficiency occurs where isoquants are tangent
Edgeworth Box Diagram y Total Labor Total Capital 1 2 A 1

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Edgeworth Box Diagram y Total Labor Total Capital 1 2 A 1 2
Edgeworth Box Diagram y Total Labor Total Capital At each efficient point, the RTS (of k for l ) is equal in both x and y production 1 2 3 4 p 4 p 3 p 2 p 1

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Production Possibility Frontier The locus of efficient points shows the maximum output of y that can be produced for any level of x we can use this information to construct a production possibility frontier (PPF) shows the alternative outputs of x and y that can be produced with the fixed capital and labor inputs that are employed efficiently
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## This note was uploaded on 11/06/2009 for the course ECON ECON111 taught by Professor Smith during the Spring '09 term at Punjab Engineering College.

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ch13 - Chapter 13 General Equilibrium and Welfare Perfectly...

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