Question

1. Critically analyse what implications the Edgeworth box for the consumption choices of two individuals has for government interventions associated with efficiency and equity.

Answer 1

The Edgeworth box is used frequently in general equilibrium theory. It can aid in representing the competitive equilibrium of a simple system or a range of such outcomes that satisfy economic efficiency. It depicts two individuals in one box showing their Indifference curve from their respective sides. The diagram below show the indifference curve for two individuals O, A consuming two goods apples and banana. Refer to the diagram initially the IC of O is ICO and A is ICA. Consumers always try to consume more, gain as much utility as they can with given price and budget constraint. Edgeworth box diagram assumed that there is non-satiation of consuming commodities. It means that it cannot be efficient to have total consumption of any good which is less than the output of the good. Both the individuals have strictly quasi-concave utility function. Therefore the indifference curves for individuals are convex to their origin.

In first IC curve no one is pareto efficient and there is possibility to exchange goods to make everyone better off. Once they start exchanging goods and due to non satiation assumption both O and A increased their consumption and shifted their IC curve rightward to ICO1 AND ICA1 respectively. Still there are chances to increase consumption level and once again IC curve shifted to ICO2 and ICA2 respectively. Here we have Pareto efficient point where it is not possible to make one person better off without making one worse off.

there are no role from government to maintain efficiency and equity in the market, market automatically reaches at pareto efficient point where everyone is gaining maximum from the trade and no one is worse off.