Answer to Question #124834 in Microeconomics for marq

Question

b) Assuming the two goods X and Y and two persons, analyze the exchange of goods between the two using the Edge worth Box framework indicating the Pareto efficient allocation (16Marks).

Answer 1

Allocation of goods X and Y between person 1 and person 2 is Pareto efficient if, it is impossible to make one person better off without making the other person worse off. Therefore, the edge worth box frame, allows the study of exchange between two individuals for different commodities.

The consumption of good X is measured along the horizontal axis while consumption of good Y is measured along the vertical axis. Additionally, person 1 is located at the bottom left corner while person 2 is located at the top right corner of the edge worth box.Therefore,moving to the right along the bottom horizontal axis of the box, increases the consumption of person 1, for good X, while moving to the left along the top horizontal axis increases the consumption of person 2 for the same good X.

Similarly, moving up along the left vertical axis, increases the consumption of Person 1 for the good Y,while moving downwards along the right vertical axis , increases the consumption of good Y for Person 2.Hence, moving to the North East direction of the edge worth box makes person 1 better off than person 2, while moving to the South West makes person 2 better off than person 1. In the Edge worth box diagram, the allocation is not Pareto efficient since, It is possible to exchange commodities between Person 1 and Person 2 so as to make them both better off. Where the initial endowment "w" represents the amount of commodities X and Y, that is available for exchange between the two persons, and the exchange of goods X and Y is drawn from the indifference curve of both individuals which is convex to their location.

We make person 2 better without making 1 worse off by moving along the indifference curve of person 1 and person 1 better without making 2 worse off by moving along the indifference curve of person 2, hence Pareto efficiency.

References

Dr. Dewett, K. K., & Navalur,M. H,. (2006). Modern Economic Theory. S chand: Reprint Edn