The green lens area represents the gains from trade

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The green lens area represents the Gains from Tradeto be had when each person trades with the other person to a point where (1)the gains from trade disappear(2)The MRTS1= MRTS2Labour input L2Capital Input K1Capital Input K2AECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
ECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
ECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
ECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
Figure 15.9 A Production Edgeworth BoxPancake, Inc.’s labor inputs2018161512108642Cereal, Inc.’s capital inputs012QP1QP2CI’sQP3isoquants1028466QC348QC2210PI’sisoquantsQC11202468101215161820Cereal, Inc.’s labor inputsPancake, Inc.’s capital inputsAn Edgeworth box can be used to determine the efficient input allocation between two firms. In this case, Cereal, Inc.’s and Pancake, Inc.’s labor inputs are on the horizontal axes and their capital inputs are shown on the vertical axes.QC1, QC2, and QC3are examples of Cereal, Inc.’s isoquants, and QP1, QP2,and QP3are examples of Pancake, Inc.’s isoquants.ECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
The isoquants for the two firms are bowed outward from the origin because of our assumption of a diminishing marginal rate of technical substitution (MRTS).MRTS, the slope of the isoquant, indicates the rate at which two inputs can be traded off while maintaining a constant level of production (the ratio of the inputs’ marginal products).Just as with the exchange efficiency example, input efficiency is achieved when the isoquants for the two firms are tangent, orKLLKMPMPMRTSCI's PI's CIPILLLKLKCIPIKKMPMPMRTSMRTSMPMPECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
Figure 15.10 Edgeworth Box with Two Sets of IsoquantsPancake, Inc.’s labor inputsCereal, Inc.’s capital inputs201816151210864201210284G6648QC2Cereal, Inc.’s MRTSLK=FQC1Pancake, Inc.’s MRTSLK2101202468101214161820Cereal, Inc.’s labor inputsPancake, Inc.’s capital inputsQP2QP1A Pareto-efficient allocation of capital and labor inputs occurs at a tangency between Cereal, Inc.’s and Pancake, Inc.’s isoquants.Point Fshows a possible allocation of labor and capital between Cereal, Inc. and Pancake, Inc. Because it lies on the intersection of isoquants QC1and QP1and not at the tangencyF is an inefficient allocation.G, which lies at the tangency between QC2and QP2,is a Pareto-efficient input allocation.ECO 200 - Microeconomics General Equilibrium Lecture 14 Wednesday, July 13, 2016
From Chapter 6, we know that cost-minimizing firms set their MRTSequal to the ratio of input prices (wage, W,and rental rate of capital, R)With this in mind, input efficiency impliesAgain following the example of exchange efficiency, we can use a production contract curveto map out all of the efficient input allocations.

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