Efficiency in Exchange ■ Assumptions o Two consumers(countries) ● Two goods o Both people know each others preferences o Exchanging goods involves zero transaction costs o James Karen have a total of 10 units of food and 6 units of clothing Chapter 16 Slide 16
Chapter 16 Slide 16 Efficiency in Exchange ◼ Assumptions ⚫ Two consumers (countries) ⚫ Two goods ⚫ Both people know each others preferences ⚫ Exchanging goods involves zero transaction costs ⚫ James & Karen have a total of 10 units of food and 6 units of clothing
The Advantage of Trade Individual initial alocation Trade Final allocation James 7F 1C -1F+1C 6F2C Karen 3F 5C +1F.-1C 4F 4C Karen's MRS of food for clothing is 3 James's MRs of food for clothing is 1/2 Karen and James are willing to trade: Karen trades 1C for 1F. When the MRS is not equal there is gain from trade. The economically efficient allocation occurs when the MRS is equal Chapter 16 Slide 17
Chapter 16 Slide 17 The Advantage of Trade James 7F, 1C -1F, +1C 6F, 2C Karen 3F, 5C +1F, -1C 4F, 4C Individual Initial Allocation Trade Final Allocation Karen’s MRS of food for clothing is 3. James’s MRS of food for clothing is 1/2. Karen and James are willing to trade: Karen trades 1C for 1F. When the MRS is not equal, there is gain from trade. The economically efficient allocation occurs when the MRS is equal
Efficiency in Exchange a The Edgeworth Box Diagram Which trades can occur and which allocation will be efficient can be illustrated using a diagram called an Edgeworth Box Chapter 16 Slide 18
Chapter 16 Slide 18 Efficiency in Exchange ◼ The Edgeworth Box Diagram ⚫ Which trades can occur and which allocation will be efficient can be illustrated using a diagram called an Edgeworth Box
Exchange in an Edgeworth Box Karen's Food 10F 4F 3F K 6C The initial allocation before trade is a: james The allocation after trade is B: James has 7F and 1c& Karen has 6F and 2c Karen has 3F and 5c has 4F and 4c Jamess Karen’s Clothing Clothing 4C +1C 1c 5C -F 6C 6F 7F 10F James's Food
Exchange in an Edgeworth Box 10F 0K 0J 6C 10F 6C James’s Clothing Karen’s Clothing Karen’s Food James’s Food 2C 1C 5C 4C 4F 3F 6F 7F +1C -1F The allocation after trade is B: James has 6F and 2C & Karen has 4F and 4C. A B The initial allocation before trade is A: James has 7F and 1C & Karen has 3F and 5C
Efficiency in Exchange Efficient allocations f Jamess and Karens mrs are the same at b the allocation is efficient This depends on the shape of their indifference curves Chapter 16 Slide 20
Chapter 16 Slide 20 Efficiency in Exchange ◼ Efficient Allocations ⚫ If James’s and Karen’s MRS are the same at B the allocation is efficient. ◆This depends on the shape of their indifference curves