PAM_2000_Spring_2009_Lecture_18

PAM_2000_Spring_2009_Lecture_18 - PAM2000Lecture18 n Agenda...

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PAM 2000 Lecture 18 n Agenda q General equilibrium: Edgeworth Box q The contract curve q The role of prices q Welfare theorems q Production possibility frontier
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Interactions Between Consumers n Consider interactions between consumers: n Assume : q There are only 2 consumers, Jane and Denise q There are 2 goods, firewood and candy
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Interactions Between Consumers n Each consumer is endowed with a certain amount of each good, and cannot get more of either (a “pure exchange economy”) n Jane and Denise can trade with each other at zero cost n Both have normal ICs (convex, etc.) n There is no interdependence between their utilities n That is, one person’s utility does not affect the other’s utility
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Endowments in an Edgeworth Box
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Endowments in an Edgeworth Box
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Edgeworth Box  n Each of them has a set of ICs n We can consider trade between the two by just flipping around Denise’s ICs n This creates an Edgeworth box
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Endowments in an Edgeworth Box
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Edgeworth Box (con’t) n Suppose that the initial endowment is for Denise is to have lots of candy and little wood, and the reverse for Jane n Think about their utilities at their initial endowment point of e n Can both benefit if they trade? n When will they stop trading?
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Conditions for Equilibrium n They will stop when neither one can be made better off by more trades n That occurs when their ICs are tangent, or when their slopes are equal, or when their marginal rates of substitution are equal n That is, when the rate that Denise is willing to give up wood to get more candy is equal to the rate at which Jane is willing to give up wood to get more candy
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Conditions for Equilibrium (con’t) n What we can say about point f : q The ICs are tangent at point f q The MRS of each consumer are equal at point f q No further mutually beneficial trades possible
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Conditions for Equilibrium (con’t) n The allocation of the two goods is Pareto Efficient at point f n One person cannot be made better off without making the other one worse off
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The Contract Curve n
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