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Unformatted text preview: eir isocost line),  every market is in equilibrium (the quantity demanded in every market is equal to the quantity supplied in every market). 85 Such a set of prices, if it exists, is called an equilibrium price vector. So the most basic and central question of general equilibrium theory can be stated simply as: Is there such an equilibrium price vector? How do we prove that it exists? Why are we concerned mainly with equilibrium prices and not the quantities or other variables? Well, this is because once we know the equilibrium price vector; we can calculate all other economic variables accordingly since we have defined demands in terms of prices. To illustrate this point...  if we know equilibrium prices, we can use consumer demand functions to calculate all of the individual quantities of goods demanded;  we can also use producer demand functions (derived from their production functions) to calculate all individual quantities of factors demanded;  from all individual quantities demanded, we can obtain the corresponding aggregate quantities by the horizontal summation technique;  finally, we can use the market equilibrium conditions to calculate the aggregate supplies from the aggregate quantities of goods or factors demanded. To summarize, once we know the equilibrium price vector, we can determine all of the other relevant economic variables in the economy. There are many general equilibrium models with various special features such as corporate income taxes, personal income taxes, international trade, economic development and even money markets. We will concentrate on the following basic GE models of a simple economy. While these models are simple and clearly not overly realistic, they are quite useful in demonstrating the salient features of general equilibrium theory without dwelling too heavily on technical details or being encumbered by performing thousands of calculations.  The pure exchange economy is an economy with two consumers, A and B, exchanging two goods, X and Y. This is essentially a simple barter economy.  The simple p...
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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