601 The Edgeworth Box

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Okay! We’re now moving onto general equilibrium and welfare economics! And I can tell you that this topic isn’t covered in detail in your lectures because we’re expected to go read up and explore by ourselves. But there’s nothing to worry because we are gonna discuss it here on quickienomics.com!

So what’s general equilibrium and what’s the big deal about it? All the equilibrium stuff you’ve been learning previous are called PARTIAL equilibrium. Everything including the equilibrium quantity and price of x in your market structure are partial equilibrium. It is partial because it does not look at the economy as a WHOLE. Refrain from thinking Macroeconomics because there is a huge difference.

Taking market structures for example, we only focus on good x. But in reality, there are more than 1 type of goods and the labour market has to be taken into account too. We relax the assumptions and we now assume that there are 3 markets in the economy: market for goods x, y and labour as well.

So why are economist concerned about general equilibrium? That’s because we want to understand economic behaviour as a whole and everybody wants to maximize their utility. And with the constant battle between supply and demand, we need to understand the consequences of such a battle on the consumers’ utility and firms’ profits.

To summarize, general equilibrium studies the behavior of society, just like how consumer theory studies the behavior of individuals.

We start with the Edgeworth Box. It is a useful tool to study resource distribution. So what does that mean?

Imagine 2 individuals with different endowments of x and y. How can they trade with each other and maximize each others utility?

In simple words, I’ve got 3 boxes of candy and 12 packets of potato chips. You’ve got 7 boxes of candy and 4 packets of potato chips. I’m a candy freak and you love potato chips. How are we gonna trade so that we are both happy? Are you gonna talk about opportunity cost? Sorry buddy, impossible because we ain’t talking about production. Totally different from chapter 1 eh?

So basically, the Edgeworth box is taking 2 individuals’ budget constraint and indifference curves and combining them into a graph that looks like a box. It looks so complicated in your lecture notes and textbooks but it’s actually pretty damn simple. After watching the video, I hope you’ll go “that’s all???”




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