Chapter 10/General Equilibrium and Economic Welfare



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Figure 10.4


6) Robinson starts out with 10 lobsters and 5 coconuts. Friday starts out with 10 lobsters and 15 coconuts. After trading, Robinson ends up with 8 lobsters and 10 coconuts. Robinson feels neither better nor worse off than when he started but cannot get Friday to agree to any more trades. Friday feels better off than when he started. Draw the Edgeworth box consistent with this story.
Answer: See Figure 10.4

Diff: 2


Topic: Trading Between Two People
7) Consider a society consisting of just a farmer and a tailor. The farmer has 10 units of food but no clothing. The tailor has 20 units of clothing but no food. Suppose each has the utility function U = F * C. The price of clothing is always $1. If the price of food is $3, does a competitive equilibrium exist? If not, what will happen to the price of food?
Answer: The farmer will have $30. His budget line is 30 = 3F + C. His budget line is tangent to an indifference curve when C/F =3. Substituting yields 30 = 6F or F = 5 and C =15. The tailor's budget line is 20 = 3F + C. His budget line is tangent to an indifference curve when C/F =3. Substituting yields 20 = 6F or F = 3.33 and C = 10. In total 8.33 units of food and 25 units of clothing are demanded. There is excess demand for clothing and excess supply of food. The price of food will fall. When the price of food is $2, both markets clear.

Diff: 2


Topic: Competitive Exchange


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