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The Edgeworth Box. The Basic Theorem. The basic theorem in welfare economics: A market, exchange, economy will achieve efficient resource allocation . We intend to show the basics of that proof. Some Basic Assumptions. A simple economy:Harry and Sally. Some Basic Assumptions.

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the edgeworth box

The Edgeworth Box

Lectures in Microeconomics-Charles W. Upton

the basic theorem
The Basic Theorem
  • The basic theorem in welfare economics:

A market, exchange, economy will achieve efficient resource allocation.

  • We intend to show the basics of that proof.

The Edgeworth Box

some basic assumptions
Some Basic Assumptions
  • A simple economy:Harry and Sally.

The Edgeworth Box

some basic assumptions1
Some Basic Assumptions
  • A simple economy:Harry and Sally.
  • There are two factors of production, capital, K, and labor, L.

L = LH + LS

The Edgeworth Box

some basic assumptions2
Some Basic Assumptions
  • A simple economy:Harry and Sally.
  • There are two factors of production, capital, K, and labor, L.

L = LH + LS

  • These two factors of production can be used to produce either apples or bananas.

The Edgeworth Box

three basic questions
Three Basic Questions
  • How many apples and how many bananas should be produced?

The Edgeworth Box

three basic questions1
Three Basic Questions
  • How many apples and how many bananas should be produced?
  • How should the apples and bananas be allocated between Harry and Sally?

The Edgeworth Box

three basic questions2
Three Basic Questions
  • How many apples and how many bananas should be produced?
  • How should the apples and bananas be allocated between Harry and Sally?
  • How should capital and labor be allocated to the production of apples and bananas?

The Edgeworth Box

the edgeworth box1
The Edgeworth Box

Apples

The Edgeworth Box

the edgeworth box2
The Edgeworth Box

Apples

Bananas

The Edgeworth Box

the edgeworth box3
The Edgeworth Box

Apples

Sally

Bananas

Harry

The Edgeworth Box

the edgeworth box4
The Edgeworth Box

Sally

Sally’s Bananas

Harry’s Bananas

Harry

Harry’s Apples

Sally’s Apples

The Edgeworth Box

the edgeworth box5
The Edgeworth Box

Sally

bs

aH

aS

bH

Harry

The Edgeworth Box

indifference curves for harry
Indifference Curves for Harry

Apples

Sally

Bananas

Harry

The Edgeworth Box

indifference curves for sally
Indifference Curves for Sally

Apples

Sally

Bananas

Harry

The Edgeworth Box

indifference curves for both
Indifference Curves for Both

Apples

Sally

C

Bananas

B

A

Harry

The Edgeworth Box

the points of tangency
The Points of Tangency

Apples

The Contract Curve

Sally

C

Bananas

B

A

Harry

The Edgeworth Box

the contract curve
The Contract Curve

Apples

Sally

Bananas

Harry

The Edgeworth Box

the core
The Core

Apples

Sally

Points in yellow area (the Core) make Harry and Sally better off.

Bananas

Harry

The Edgeworth Box

more on the core
More on the Core

Apples

Points on black portion of contract curve are Pareto Optimum.

Sally

Points in yellow area (the Core) make Harry and Sally better off.

Bananas

Harry

The Edgeworth Box

getting there
Getting There

Apples

Points on black portion of contract curve are Pareto Optimum.

Sally

Harry and Sally will move to the contract curve via voluntary exchange.

Points in yellow area (the Core) make Harry and Sally better off.

Bananas

Harry

The Edgeworth Box

getting there1
Getting There

Apples

Points on black portion of contract curve are Pareto Optimum.

Sally

Harry and Sally will move to the contract curve via voluntary exchange.

Points in yellow area (the Core) make Harry and Sally better off.

Here, they will end up along the black portion of the line

Bananas

Harry

The Edgeworth Box

pareto optimality
Pareto Optimality

When Harry and Sally are on the contract curve, we say that they have achieved Pareto Optimality, the economist’s equivalent of “bliss”.

Apples

Sally

Bananas

Harry

The Edgeworth Box

pareto optimality1
Pareto Optimality

When Harry and Sally are on the contract curve, we say that they have achieved Pareto Optimality, the economist’s equivalent of “bliss”.

Apples

Sally

Bananas

Harry

The Edgeworth Box

pareto optimality2
Pareto Optimality

When Harry and Sally are on the contract curve, we say that they have achieved Pareto Optimality, the economist’s equivalent of “bliss”.

Apples

Sally

Bananas

It is impossible to make Harry better off without making Sally worse off (or vice versa)

Harry

The Edgeworth Box

pareto optimality3
Pareto Optimality

When Harry and Sally are on the contract curve, we say that they have achieved Pareto Optimality, the economist’s equivalent of “bliss”.

Apples

Sally

If they are not on the contract curve, it is possible to make one or both better off without making the other worse off.

Bananas

It is impossible to make Harry better off without making Sally worse off (or vice versa)

Harry

The Edgeworth Box

slide27
End

©2006 Charles W. Upton

The Edgeworth Box