Consider a model of pure exchange with two consumers—Ronald and Mikhail— and two goods. Assume that consumer preferences are convex as in lectures. Ronald is endowed with 5 units of good A and 10 units of good B. Mikhail is endowed with 5 units of good A and 5 units of good B.
a. Draw an Edgeworth box with all appropriate labels and identify the endowments of each consumer.
b. Suppose that at the endowment point, the consumers’ indifference curves are NOT tangent to each other. Draw the indifference curves in the Edgeworth box and explain why there are Pareto-improving exchanges that can be made?
c. Draw a new Edgeworth box with a price line through the endowment. Draw a situation in which there is excess demand for good A. What should happen to the magnitude of the slope of the price line to establish a competitive equilibrium?
d. Depict a competitive equilibrium allocation in this Edgeworth Box. What does this tell us about the efficiency of competitive equilibrium?