Question

Can someone please explain the edgeworth box to me by typing in a way i can see and understand? what determines the contract curves path?

Answer 1

Edgeworth Box is used to analyze exchange taking place between two people. It is a graphical representation.

Let us consider two people A and B. A’s consumption bundle is (Xa1, Xa2) . B’s consumption bundle is given by (Xb1, Xb2).

Let the initial endowments be (Wa1, Wa2) and (Wb1,Wb2). It is the allocation with which consumers start.

Let the total amount of goods consumed= total amount available.

(Xa1+ Xb1)= (Wa1+ Wb1)

(Xa2+Xb2)= (Wa2+ Wb2)

This is known as a feasible allocation.

They will exchange some of these goods.

The width of the Edgeworth box measures total amount of good 1 in the economy. Height measures total amount of good 2. Person B’s consumption choices are measured from upper right hand corner and Person A’s consumption choices are measured from lower left hand corner. All feasible allocations in the economy are measured in Edgeworth Box. M represents the consumption bundle. W represents initial endowments.

We will follow the standard consumer theory diagram. A’s indifference curves are drawn in the way it usually is. But B’s indifference curves are different. To draw B’s indifference curve we draw it the way we usually do (convex to the origin) and then turn the diagram upside down and then it is overlaid on the Edgeworth Box.This is because B’s origin is on upper right hand corner. From A’s origin if we move to the right and up, we will get the allocations preferred by A. From B’s origin if we move down and to the right we will get allocations that are prefered by B. Thus the edgeworth box helps us to decipher the preferences of both the consumers.

Now we come to the concept of pareto efficient allocations.Pareto Efficient allocation is the one where there is no way to make anyone better off without making someone else worse off. The indifference curve must be tangent at any Pareto efficient condition in the Edgeworth Box. If the two of them are not tangent then it means that they have crossed each other. If they cross it means that it is possible to make someone better off without making someone worse off. Thus the points where the indifference curves are tangent to each other are pareto efficient. The set of all Pareto efficient points in the Edgeworth Box is known as contract curve. It normally stretches from A’s origin to B’s origin.