Answer to Question #209396 in Microeconomics for kevin

Question

Construct an edge worth box diagram and show how production, efficiency and equilibrium is achieved in an economy. 

Answer 1

The Use of Edgeworth box

The points X1, X2 and X3 show the different allocations of good x and good y to consumer A and B. At X1, consumer A is on his indifference curve, A1 and consumer B on indifference curve E3.

However, at that point the allocation is not Pareto-efficient because the utility of one consumer affects the utility of the other significantly.

Pareto-efficiency is achieved when the indifference curves touch tangentially as the case with curves E1 and A3.

At this point both the consumers can achieve higher utility without reducing other's utility.

By this efficiency is achieved by the help of the Edgeworth Box diagram.

Production

In production the Edgeworth Box is used to show the combination of two different goods that can be produced with a given set of inputs such as labour and capital.

The isoquants shown in the image below shows different production levels of good y and good x

When we plot this two graphs together, we come up with Edgeworth Box diagram showing different combination of inputs producing both good x and y as shown below.

Equilibrium in an economy

When there is equilibrium, the number of bananas Gilligan wants to buy is exactly equal to the number of bananas Mary Ann wants to sell and the number of coconuts Gilligan wants to buy is exactly equal to the number of coconuts Mary Ann wants to sell.