General Equilibrium with Production Flashcards
(13 cards)
What is the Crusoe–Friday model?
A 2-person economy where both individuals can produce and trade — integrating both production and exchange into one general equilibrium model.
What are the key elements of the Crusoe–Friday model?
2 individuals: Crusoe and Friday
2 goods (e.g. fish and bananas)
Each can produce both goods using labour
Trade is possible between them
What do individual PPFs represent?
The set of feasible production bundles each person can achieve given their labour and production technology.
What is autarky in this model?
A situation where each person consumes only what they produce, with no trade.
Why do Crusoe and Friday trade?
Differences in opportunity cost — each specialises in the good they can produce more efficiently, leading to mutual gains from trade.
How do relative prices determine specialisation?
Each agent compares price ratio to their MRT.
If price > MRT → specialise in producing that good
If price < MRT → switch production
What budget constraint do individuals face?
After producing their chosen bundle, they trade along a budget line with slope = −𝑃𝑋/𝑃𝑌 , subject to income from production.
What conditions define general equilibrium with production?
Profit-maximising production
Utility-maximising consumption
Market-clearing in all goods
Feasible production and consumption plans
What is required for Pareto efficiency in this model?
MRT (Crusoe) = MRT (Friday) = price ratio
MRS (Crusoe) = MRS (Friday) = price ratio
→ So:
MRS=MRT= Px/Py
Does the First Welfare Theorem hold in the Crusoe–Friday model?
Yes — under perfect competition and no distortions, equilibrium is Pareto efficient, even with production.
Can we redistribute to reach any Pareto optimum?
Yes — via transfers or initial endowment redistribution, we can reach any Pareto efficient outcome through markets.
What does the combined Edgeworth + PPF diagram show?
Production point (on PPF)
Budget line (based on relative prices)
Consumption point (on contract curve within Edgeworth box)
→ All aligned at price = MRS = MRT
Why is the Crusoe–Friday model important?
It’s the culmination of consumer theory, producer theory, and market theory — showing how all elements of microeconomics fit together in a single model.
