General Equilibrium Teory - DeSerpa
What categorizes a competitive economy?
An economy is competitive if all agents (buyers and sellers) in all markets (final product markets and resource markets) act as price takers.
When does a competitive equilibrium occur?
A competitive equilibrium occurs when, for a given set of prices, the commodity bundles chosen by the consumer and the input-output choices of the producer satisfy:
1. Each consumer maximizes utility subject to his budget constraint.
2. Each firm maximizes profits over all feasible input-output combinations, determined by the nature of its production function.
3. The market clears (supply and demand are equal in each market)
4. Each firm earns only normal profits on its operations.
What is the production possibility curve?
The production possibility curve defines the limits of output combinations that are feasible, given technological and resource limitations.
What is the other name of the Production Possibility Curve?
Transformation Curve
What is the format of the Possibility Production Curve?
It is concave to the origin
What measures the Marginal Rate of transformation?
It measures the small changes in X and Y. It is an exact measure of relative marginal costs (MRT=MCx/MCy)
Beyond the Relative Marginal Cost ratio, what else does the MRT determine?
The MRT also determines a price ratio that must prevail if product markets are to be in equilibrium (MRT=MCx/MCy=Px/Py)
Can the MRTS and MRT determine absolute prices?
No, both ratios only determine relative factor prices (w/r) and relative output prices (Px/Py)
Is it possible to determine all prices in a general equilibrium model?
In a competitive equilibrium, all prices except one are determinate and must be consistent with the curvatures of isoquants and the transformation curve. Once one price is arbitrarily set, the remaining prices may be calculated.
What is a pure exchange economy?
An economy without production or money
What is a contract curve in an Edgeworth Box?
The contract curve links all the points of tangency between indifference curves. At these points, the marginal rates of substitution are equal (MRSa=MRSb)
What it is the budget constraints?
Each individual is constrained to choose a commodity bundle that costs no more than his initial endowment
When does the exchange equilibrium occur?
The exchange equilibrium occurs when the conditions of the budget constraints are satisfied, and also, each individual fulfills the assumption that more is preferred to less (monotonicity)
What is the Walras's Law?
For any economy with n commodities, equilibrium in n-1 markets implies that the remaining (nth) market must also be in equilibrium
How are the profits distributed in a competitive economy in equilibrium?
In a competitive equilibrium, economic profits do not exist, only normal profits
What does the Say's law describe?
Say's law describes the relationship between the total value of goods, profit, and factor income (π + wL + rK = PxX + PyY). This law suggests that economic activity must generate sufficient income to purchase all goods produced.
Competitive Equilibrium
State of an economic system in which all markets are purely competitive and in simultaneous equilibrium; all consumers maximize utility subject to their budget constraints, all producers maximize profits, all markets clear, and economic profits and quasi-rents are equal to zero
Contract Curve
Locus of points of tangency between indifference curves in an Edgeworth box diagram, characterized by equal marginal rates of substitution for each consumer
Endowment
A bundle of commodities and/or resources owned by individuals in some initial situation before production and exchange decisions have been made
Exchange Equilibrium
An allocation of commodities in a pure exchange economy and a specific price ratio such that all individuals are maximizing utility (given initial endowments and prices) and total consumption is equal to total endowment of each commodity
Excess Demand Function
A mathematical representation of the difference, in any particular market, between quantity demanded and quantity supplied as a function of the prices of each commodity and resource in the economy. A market clears if its excess demand function is equal to zero.
Marginal Rate of Transformation
The rate at which the output of one commodity must be reduced as the output of an alternative commodity is increased, assuming resources are being allocated efficiently.
Numeraire
A commodity that is singled out as a standard of value. The prices of all other commodities and resources are measured in relation to that of the numeraire.
Production Contract Curve
Locus of points of tangency between isoquant curves in an Edgeworth production box, characterized by equal marginal rates of technical substitution for each commodity.
Pure Exchange Economy
An economy in which no production takes place, so that economic activity is limited to trading by individuals, each of whom is assumed to be endowed with some initial commodity bundle.
Say's Law
The aggregate value of all goods produced must be equal to that of all resources utilized in production, whether or not the economy is in general equilibrium.
Transformation Curve
The locus of output mixes corresponding to efficient combinations of input: derived from the production contract curve. It is also known as the production possibility curve.
Walras' Law
If all markets except one are in equilibrium, the remaining market must also be in equilibrium.
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