Page 387 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes The Fig. 26.8 represents the general equilibrium of exchange. Let’s take two consumers A and B, they
have quantity of product X and Y respectively. O is original point of consumer A and O is original
B
a
point of consumer B (revert the diagram to understand). The horizontal lines of both the product O
a
and O represent product Y and vertical line represents product X. A , A and A curves represent
1
2
3
b
the indifference drawing of product A while B , B and B for B. Any points in this box represent
3
1
2
the expected distribution of production between both the consumers. See point E where A and B
1
1
indifference curves intersect each other. In this stage, A has O Y units of product Y and O X units of
a a
a a
products X. B has O Y of Y and O X units of X. The MRS on point E is not equal to its price because the
b b
b b
slope of curve is not equal. Thus the equilibrium exchange point E is not for product X and Y to A and
B. But both have the base of exchange.
Suppose that A needs more of product X and B needs more of product Y and they come from E
to R. A gets more quantity of X in point R, while B gets more quantity of Y on it. The condition of
B does not change because he still on that indifference curve B , but A is in better condition on R
1
because he steps ahead from A to A indifference curve. But if A and B both come from E to P then
3
1
the condition of A remains same because he is still on that indifference curve A . Since B goes onto
1
B so his condition gets better. They both in good indifference curves A and B respectively when
3
2
2
they step from E to Q.
Fig. 26.8
X
X
b
O
b
E C
Y Y
a b
R
A 3
Y Q Y
A
2 B
P B 2 1
C A
B 1
3
O X
a a X
Thus, P, Q and R are three thinkable points in exchange. When these points are added by CC line, then
contract curve has made. The general equilibrium of exchange will always on contract curve where
MRS = MRE . This general equilibrium of exchange is not unique because it can happen in any
A XY B XY
point of contract curve.
(ii) General Equilibrium of Production
The general equilibrium of production comes when the MRTS between labour and capital of product X
(MRTS ) is equal to MRTS of the same of product Y (MRTS ). MRTS = MRTS .
Y
LX
LK
LK
X
LK
The Fig. 26.9 describes the general equilibrium of production. To produce two products X and Y,
economy has limited two factors labour (L) and capital (K). O is the original point of labour factor.
Y
Labour has indicated vertically while capital is on horizontal line with original point O . The vertical
Y
line O and O represent product X and horizontal line represents to Y.
X Y
380 LOVELY PROFESSIONAL UNIVERSITY