Question

The textbook has developed the Edgeworth box diagram and the concept of the production efficiency locus or contract curve in the context of the production of two goods with two factors. Apply the Edgeworth box apparatus to the context of consumption of two goods by two consumers, and, in particular, explain how welfare for the two consumers as a whole when on the contract curve relates to welfare when the consumers are not on the contract curve.

Answer 1

Let's say we have an Edgeworth box diagram wherefrom the bottom left corner we'll measure the quantities and utilities gained by person A and from the top right corner we'll measure the quantities and utilities gained by person B

we have two commodities X(measured through the horizontal axis) and Y(measure through the vertical axis)

let's say we are at point m first.

now at point M, MRS of person A>MRS of person B. that means MUx/MUy of person A is more than MUx/MUy of person B.

hence the person A values X very highly and person B values X not very much. hence person A will be giving up much more unit of Y to gain one unit of X and on the other hand, person B will be happy to give up a unit of X by not charging much of Y.

hence if the exchange takes place, person B will be gaining much more of good Y in exchange for good x than he requires as per his MRS. hence he will gain more utility than the existing IC'1 curve. this exchange will go on till we rach point N where MRS of both the person is equal.

this exchange will raise person b's utility level but doesn't hamper the utility of person A negatively. hence the total social welfare is gained and it is maximised when the MRS of the two persons get equal. hence the welfare maximising points will be at the tangency points of the two-person indifference curves. the locus of these points is called the contract curve.

hence utilities are maximised throughout the contract curve. when not in the contract curve society deviates from their maximum possible utility from where there will be some scope of improving the welfare through an exchange.

give the answer a thumbs up.