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Flashcards in General Equilibrium Deck (25)
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1

3 basic assumptions of general equilibrium theory (i.e. can all markets clear?)

1. No frictions (no externalities, no distortionary taxes)
2. Price-taking (no market power)
3. Many agents

2

What does the axis length of an edgeworth box represent?

Total endowment of good

3

What characterises competitive equilibrium in an exchange economy model?

MRS(a) = MRS(b) = p1*/p2*

4

What is a general competitive equilibrium?

1. Vector of prices and an allocation such that:
(i) Firms maximise profits subject to production function
(ii) Profits distributed to households
(ii) Consumers maximise utility subject to budget constraint
(ii) All markets clear (i.e. total demand equals total endowment of goods, so excess demand = 0)

5

What assumptions needed for competitive equilibrium to exist in an exchange economy?

1. Consumer preferences are:
(i) Continuous (small price changes don't result in large jumps in quantity demanded)
(ii) Monotonic (more = better)
(iii) Convex (averages better than extremes)
2. W>0 (endowment > zero)

6

What is a Walrasian equilibrium?

competitive equilibrium in an exchange economy

7

Why might competitive/Walrasian equilibrium not exist?

1. If an individual’s demand is discontinuous, competitive equilibrium might not exist
(i) e.g. agent might be endowed with a good they do not want to sell at any price
(ii) some goods only come in discrete quantities

8

How much profit do firms make in a competitive market w/constant returns to scale?

Zero

9

What characterises competitive equilibrium in an production economy model?

MRT = MRS = w*/p*

10

Illustrate and explain how increasing returns to scale might mean non-existence of competitive equilibrium in production economy model?

SEE NOTES (titled Non-existence: increasing returns to scale)

1. Initially not a competitive equilibrium
2. Change relative prices, rotating budget constraint to try and achieve competitive equilibrium
3. Due to increasing returns to scale, firm’s optimum jumps
4. Discontinuous jump = reason for non-existence

11

Individual's maximisation problem in exchange economy model? In words and equation

1. Maximise utility (function of consumption of x1 and x2)
2. Subject to constraint that total spending less than/equal to total value of endowments
3. max U(x) st p*x ≤ p*w

12

Consumer maximisation problem in production economy model? Words and equations

1. Maximise utility (function of leisure and consumption)
2. Subject to constraint that total spending equals total income
3. max U(x,1–L) st profit + w*L = px

13

Firm maximisation problem in production economy model? Words and equations

1. Maximise profit (isoprofit line)
2. Subject to constraint of production function
3. max px-wL st x ≤ F(L)

14

Draw diagram to show gain from trade following liberalisation (1 country and ROW)

SEE NOTES (now remove tariffs)

15

Are consumers always better off when country opened up to world trade vs autarky?

Yes - ability to trade at any world prices other than autarky prices makes consumers better off

16

Draw diagram to show that consumers in 2 autarkic countries benefit from trade (assuming consumers are identical)

SEE NOTES (trade result)

17

Draw diagram to show how some consumers might be made worse off by trade if consumers are heterogeneous

SEE NOTES (if consumers different, then some may be made worse off by trade)

18

Draw diagram to show how some producers might be made worse off by trade

SEE NOTES (producers may suffer from trade)

19

Stopler-Samuelson theorem

1. increase in demand for a good raises demand for the factor used most intensively in its production
2. E.g. wage rises if demand for the labour-intensive good rises

20

Rybczynski theorem

increase in a country’s endowment of a factor will cause increase in output of the good which uses that factor intensively and a decrease in the other

21

What is the contract curve? What does it represent?

1. locus of points where MRS(a)=MRS(b)
2. Represents the set of all Pareto efficient points

22

Walras' law (words and equations)

1. aggregate net/excess demand for each good identical to zero (i.e. equal to zero for all possible prices, not just equilibrium prices):
2. (i) p1*z1(p1, p2) + p2*z2(p1, p2) = 0
(ii) where z1(p1,p2) = xa1(p1,p2) + xb1(p1,p2) – wa1 – wb1

23

Why does a firm with constant returns to scale make zero profits in a competitive market?

1. CRTS means AC=MC
2. When MC=AC, profits are zero

24

3 key international trade concepts (Venables 2016 lecture)

1. Comparative advantage – country has comparative advantage in good 1 if it’s relatively more expensive under free trade vs autarky (i.e. p1/p2 < p1*/p2*)
2. Trade pattern – each country exports good in which it has comparative advantage
3. Gains from trade – trade enlarges consumption possibility set & enables consumer to reach higher indifference curve

25

A country has a comparative advantage in good 1 if...

it’s relatively more expensive under free trade vs autarky (i.e. p1/p2 < p1*/p2*)