General Equilibrium Model - Motivation
Now let us consider what happens when there is a fixed amount of goods X and Y available in an economy and the parties H and F wish to trade.
Edgeworth Box
General Equilibrium Model - Motivation | |
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In the previous section we learnt how we could plot the endowment
of goods X and Y to H and F using graphs like this:
Now let us consider what happens when there is a fixed amount of goods X and Y available in an economy and the parties H and F wish to trade. | |
Edgeworth Box | |
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We form an Edgeworth Box by inverting one of the graphs and placing it on top of the
other so that the horizontal extent indicates the total amount of good X available in the
economy, and the vertical extent indicates the total amount of good Y.
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| Now, as we saw earlier, if H is able to move to a point on a line above IH, then H's level of satisfaction will be increased. |
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Likewise, if F is able to move to a point on a line below
IF (remember, we have rotated F's graph so it
is now upside down), then F's level of satisfaction will also be increased.
Since H and F together own all the goods X and Y in the economy, the only way for them to improve their level of satisfaction is to trade. |