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  • Print publication year: 2012
  • Online publication date: November 2012

3 - Equilibrium and Efficiency in an Exchange Economy


The 2 × 2 Exchange Economy

Key ideas: Pareto efficiency, Edgeworth Box diagram, first and second welfare theorems

In this chapter the focus shifts from the individual agent to the market. Specifically we examine the allocation that results if all economic agents are price takers and prices adjust until markets clear. Rather than attempt to bring firms and consumers into the analysis all at once, we focus here on equilibrium in which there is no production. Consumers have endowments of commodities that they may exchange. As we see later, the ideas developed here extend very directly to economies with production.

Even though this chapter focuses on equilibrium outcomes, it is helpful to keep in mind a possible adjustment process that might lead to equilibrium. Suppose that there is an auctioneer who calls out prices for each of the commodities. Consumers and firms respond with the demands that they would make at these prices. The auctioneer lowers prices in markets where there is excess supply and raises them in markets where there is excess demand. At a price-taking (Walrasian) equilibrium, all markets clear.

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References and Selected Historical Reading
Edgeworth, Francis Y 1881 Mathematical Psychics: An Essay on the Application of Mathematics to the Moral SciencesLondonC. K. Paul
Pareto, Vilfredo 1909 Manuele di economia politicaKelley
Rawls, John 1971 A Theory of JusticeCambridge, MABelknap Press
Walras, Leon 1874 Éléments d’économie politique pure, ou théorie de la richesse socialeLausanne: F. Rouge Editeur