General Equilibrium Model - Motivation

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

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.

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.

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.

General Equilibrium Model - Autarky

General Equilibrium Model - Trade

General Equilibrium Model

Copyright © 1997, 1998, 2001 Dr MoonJoong Tcha
(mtcha@ecel.uwa.edu.au)

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