Chapter 10/General Equilibrium and Economic Welfare



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Figure 10.1

8) Figure 10.1 depicts the Edgeworth box for two consumers, Al and Bruce. Explain why point "a" cannot be a competitive equilibrium.


Answer: Point "a" cannot be a competitive equilibrium because at point "a", Al and Bruce each have a different marginal rate of substitution. Since they both face the same prices in a competitive market, at least one of them is not in equilibrium.

Diff: 2


Topic: Competitive Exchange
9) Explain how it is possible for one of two people in a two-good economy to have an

absolute advantage in producing both goods, but trade can still benefit both people.


Answer: One person, when she spends all of her time producing one good or the other, can produce more of either good than the other person. This person has an absolute advantage in producing both goods. However, gains from trade exist when the opportunity costs associated with each good are different for both people. If the costs of producing one good in terms of the forgone production of the other good differ for the two people, then they can gain from trade.

Diff: 1


Topic: Production and Trading
10) Suppose a society's PPF for food (F) and clothing (C) can be written as 25 = F2 + C2. If all consumers have the same endowment and the same utility function Ui = Fi*Ci, what is the efficient product mix of food and clothing?
Answer: The marginal rate of substitution of food for clothing (dF/dC) equals F/C. The marginal rate of transformation of food for clothing (dF/dC) equals C/F. The efficient product mix occurs when F/C = C/F or C = F. Given the PPF, food and clothing will both equal sqrt(12.5).

Diff: 2


Topic: Production and Trading
11) Can consumption efficiency be achieved even if the efficient product mix is not achieved?
Answer: Efficiency in consumption implies that all consumers have the same MRS. This can be achieved with any product mix. Thus, consumers can be as well off as possible for any given product mix. If the product mix is inefficient, consumers can still make the best of it even though a different product mix could make them even better off.

Diff: 2


Topic: Production and Trading
12) How does competition ensure that the efficient product mix is attained?
Answer: In a competitive market, producers choose an output level where marginal cost equals price. Thus, Px/Py = MCx/MCy. Each consumer maximizes her own utility subject to the given prices by setting MUx/MUy = px/py. Even though each is acting independently and in her own interest, the final outcome is that px/py = MRS = MRT, which is the condition for efficient product mix.

Diff: 2


Topic: Production and Trading


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