Question

1. Using the Edgeworth box diagram, state the competitive or W equilibrium. alrasian 2. Explain the Pareto efficient allocation. Define the contract curve in this context.

Please solve the above questions

Please explain in details while stating the answers (Diagrams and explanation please)

Answer 1

1. Given the two consumers' preferences, and their initial endowments, a competitive equilibrium allocation is an allocation where both consumers are maximizing their respective utilities given their income (value of their endowment) and competitive equilibrium prices. This can be better understood using an Edgeworth Box diagram:

((p p2), (X1, Y1), (X2, y2)

In the given Edgeworth box, given the two consumers' preferences, all allocations along the line where price of x = price of y are competitive equilibrium allocations.

2. A Pareto Efficient allocation is an allocation such that no consumer can be made better off without making the other worse off. Generally, the set of Pareto Efficient allocations satisfy the tangency condition of the two consumers' indifference curves and the line passing trough all the Pareto Efficient allocations is called the Contract Curve.

Contract Curve

Along the line shown in the figure, the marginal rate of substitution of both consumers is equal. The only way to make either consumer better off is by making the other worse off.