1. A model of the market system Flashcards
What are markets described as?
Ordinal
Define General equilibrium
If all subsection of markets within a market system are in equilibrium
Define exchange economy
Simple representation of marekts
What is a market system?
- System for producing and allocating goods using price signals.
- System because we are looking at the whole economy and how it works rather than a specific sector or market
- Critique of system as it forces us to think about what we value in human well-being: efficency, equity and freddom
What are the key componenets of a market system?
* Decentralisation
* Self-interest
- Decentralisation: No central authority, operates on its own
- Self-interest: People optimise their own outcome
**(Optimisation issue is the market)
What is a partial equilibrium analysis?
The study of how quilibrium is determined in one market in isolation
E.g. Apple market
What is the general equilibrium analysis?
What is it often called?
- How demand and supply conditions interact in several makets to determine the prices of all goods (and factor prices if there is production)
- Often though of as a “Pure market system”
Complete markets asssumption:
All possible variants of goods and services can be traded at all dates
Goods
- Statistical agencies collect price data in markets and what people buy and produce. Shows aggregate activity in market economy (GDP) which is important for guiding policy.
- Includes services and non-market goods
Complete market assumption: All possible variants of goods and services can be traded at all dates
* Gov production not measured well
What is the simple exchange economy case?
* Trading
*Assumption
Trading/ swap good with no production
Role of the government:
Nee
- Enforce propery rights: Comes from a rule of law and judicial system enforces this. Allow for an exchange economy
- Enforce trades at agreed prices: Still a market but regulated (E.g. Freezing of energy bills at the £2,500 a year average)
- In practive there is no gurantee that this happens as manu countries have poorly developed court systems and corrupt governemnts who do a poor job. This prevents an effective market economy.
What are the starting assumptions of the exchange economy model?
- 2 Consumers
- 2 Goods: X and Y
- No production - Endowment economy (property rights enforceable), pure exchange
- Price takers (Competitive markets)
- Analysed using an Edgeworth Box
- Oppurtunity for transaction
Construction of the Edgeworth Box
Allocation of goods in the Edgeworth box
Allocations: Anywhere in the box which can be consumed and tells us consumption choices of an individual
An allocation at the origin point means the other person consumes everything
Indifference curves on the Edgeworth box
As consumer A moves to the right, there is an increase in utility
As consumer B moves to the left, there is an increase in utility
*Conflict as limited resources with infinite wants
Endowment
How much everyone has in the beginning
Utility and welfare at initial allocation
They can be made better off
What is infeasible?
Anything outside of the box
Define Core
All allocations that can make the consumer better off compared to where they started
Anything outside of the core will be veto because 1 person is made worse off
What has the movement achieved and what has it not achieved?
- Still a core
- Gains from trade but not fully exhausted, as there is the potential for the indifference curves to attain higher utility, making them better off
- Need to reach an allocation that maximises utility given resource constrains
- Where people end up is determined by where they begin
*No core at the origin, as they person getting everything cannot benefit from trade
- Tangency= no more gains
- P: Pareto efficient allocation: No one can be made better off without someone being worse off
MRS at Pareto efficiency
* Subsitutes
Slope of the indifference curves = MRS
Tangent is where they are the same gradient
Perfect substitutes = straight line so no tangent
Convex it’s feature so tangents
Contract Curve
- Many tangents so many Pareto efficient allocation called contract curve. Highlights that there are many ways to get efficiency.
- Pinning down 1 equilibrium: General equilibrium
- Doesn’t have to be diagonal
- Makes the marginal utilise equal to each other
Define MRS:
Willingness to trade 1 good for another good
Pareto efficient allocation is when the MRS are equal, then find the contract curve
Market mechanism
*What does competitive markets means?
*What happens at auctions?
* Why do we ignore bargaining?
- Competitive markets mean price takers
- adjusting prices at auction until market clears, justifies price signals
- Ignore bargaining, as not full market of economy and multiple consumers
Define General equilibrium/ Walrasian equilibrium
- Aggregate demand = Aggregate Supply
- Excess demand = 0
General equilibrium is the price and allocation
General equilibrium in an exchange economy
* Walras law
* Numeraire
Relative price (Terms of trade) as it only shows proportions and doesn’t need to be adjusted for inflation
General equilibrium diagram
- Moving from E to GE requires trade
- Consumers set MRS to relative price
*Price takers so only care for themselves - Only in equilibrium if all things equal
- Slope is relative price
- Straight line reflects trade
