General Equilibrium (weeks7-10)

# General Equilibrium (weeks7-10) - Create theory of general...

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(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ &KDSWHU ±²³ 0RWLYDWLRQ Create theory of general equilibrium where there are multiple markets Prior chapters studied partial equilibria where prices of other goods were exogenous (e.g., w and r) But in markets, w and r are determined at same time as P version for Econ 100b, Winter 2011 1 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ &RPSHWLWLYH (TXLOLEULXP LQ ¶ 0DUNHWV Consider demand for apples and oranges Price of oranges affects demand for apples Price of apples affects demand for oranges In partial equilibrium , hold price of oranges fixed and calculate price of apples In general equilibrium , determine price of both apples and oranges version for Econ 100b, Winter 2011 2

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(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ *HQHUDO (TXLOLEULXP³ ([DPSOH Suppose for apples, Q D = 10 – 2P A + P O Suppose for oranges, Q D = 10 + P A - 2P O Supply only depends on own price: Q S = 2P A Q S = P O version for Econ 100b, Winter 2011 3 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ version for Econ 100b, Winter 2011 4
(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ version for Econ 100b, Winter 2011 5 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ (IIHFW RI 6DOHV 7D[ RQ \$SSOHV Suppose there is a \$1 tax on apples. version for Econ 100b, Winter 2011 6

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(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ version for Econ 100b, Winter 2011 7 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ ¶ 0DUNHWV LQ WKH /RQJ·5XQ version for Econ 100b, Winter 2011 8
(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ (TXLOLEULXP LQ ([FKDQJH (FRQRP\ In an exchange economy , individuals own and trade goods No production or firms Simplification; introducing production isn’t a big headache. Consider an economy with two people: Jane and Denise Jane has 30 cords of firewood and 20 candy bars Denise has 20 cords of firewood and 60 candy bars Together, they have 50 cords of firewood and 80 candy bars Questions: What are the efficient allocations? Could a market achieve this efficient allocation? version for Econ 100b, Winter 2011 9 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ (QGRZPHQWV version for Econ 100b, Winter 2011 10

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(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ (GJHZRUWK %R[ version for Econ 100b, Winter 2011 11 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ \$VVXPSWLRQV RQ 8WLOLW\ IXQFWLRQV Utility Maximization : Each person maximizes her utility Convex Indifference curves Nonsatiation: Each person has strictly positive MU for each good No interdependence : Each person’s utility determined by own consumption version for Econ 100b, Winter 2011 12
(FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ (GJHZRUWK %R[³ &RQWUDFW &XUYH Efficiency: Impossible to make one player strictly better off without making other strictly worse off Could of course make both worse off Where indifference curves are tangent version for Econ 100b, Winter 2011 13 (FRQRPLFV ±²²%³ )HEUXDU\ ±´µ ¶²²´ (GJHZRUWK %R[³ &RQWUDFW &XUYH version for Econ 100b, Winter 2011 14

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