Unformatted text preview: reme allocation which results in everything in the economy belonging to consumer B. Similarly, OB represents the extreme allocation which results in everything in the economy belonging to consumer A. Further, note that the initial endowment point (XA, YA, XB, YB) defines the dimensions of the box and serves as the starting point for trade to occur. So, we can formulate the allocation problem in terms of the Edgeworth Box as: 158 To find a point of the Edgeworth Box such that no one can be made better off without making someone else worse off. The way we want to think about "better off" and "worse off" in our analytical formulation of this problem is by using the basic tools of microeconomic analysis, namely, the utility function and indifference curve analysis. BETTER OFF "Better off" means a higher utility level or a higher indifference curve. "No one can be made better off" means that the indifference curve cannot go any higher...
A WORSE OFF "Worse off" means a lower utility level or a lower indifference curve. "No one can be made worse off" means that the indifference curve cannot go any lower...
B XA XB Putting these two notions of "better off" and "worse off" together implies that one indifference curve cannot go any higher while the other indifference curve cannot go any lower (in the opposite direction). Geometrically, this implies that the two indifference curves must be positioned such that they are tangent to each other. The allocation problem can now be restated as: To find a point of the Edgeworth Box such that the two indifference curves are tangent to each other. 159 So how do we draw this thing? As we said above, we begin with consumer A's origin at the southwest corner and person B's origin at the northeast corner. Then we draw the two indifference curves ICA, ICB, in opposite directions (for Cobb-Douglas utility) because one set of coordinates is right side up and the other is right side down.
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.
- Spring '10