Topic 3: Equilibrium and Efficiency for an Exchange Economy
I.
Model of a Simple Economy
NOTE: Equilibrium and Efficiency are distinct topics.
We will discuss each of the topics separately and then look at the relationship between them.
II.
Efficiency (or Pareto Optimality)
A. Defn.of Efficiency
Defn.: An allocation of goods among individuals is efficient if there is no other allocation of the
economy’s resources that makes some individuals better off without making others worse off.
B. Identifying the Efficient Allocations in the EB
C. More General Discussion of Efficiency
III.
Competitive Equilibrium
A. Individual Choice
1. Preferences 2. Budget Set 3. Consumer Optimum
B. Equilibrium
1. Showing the individual consumer choice problem in an Edgeworth Box
2. Reminder on the definition of a competitive equilibrium
3. Identifying the competitive equilibrium for our exchange economy
IV. Efficiency of the Competitive Equilibrium
V. Evaluation of our Findings
A.
B.
C.
Recognition of the simple nature of our model
Efficiency of market noncompetitive market structures
Equity
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I. Model
A. Description of the Economy
This is an exchange economy. There are no firms and no production.
In order to use a graphical approach, there are only two individuals and two goods in our economy. We will refer
to the two individuals as Robert and Sally and the two goods as X and Y. Each individual has an initial
endowment of the goods. (For example, Sally might have an endowment of 2 units of each good. Robert might
have an endowment of 0 units of good X and 5 units of good Y. The endowment is information that must be given
to us.)
Each’s individual’s preferences satisfy the usual assumptions.
****B. Edgeworth Box