Lecture Microeconomics: Theory and applications (12/e): Chapter 6 - Browning, Zupan
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Prepared by Dr. Della Lee Sue, Marist College
MICROECONOMICS: Theory & Applications
Chapter 6: Exchange, Efficiency, and Prices
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
Learning Objectives
Understand why voluntary exchange is mutually beneficial.
Explain what economists mean by efficiency in exchange
and the benefits associated with the promotion of such
efficiency.
Discuss how competitive markets promote efficient
distribution of goods between consumers.
Explore the extent to which price and nonprice mechanisms
for rationing goods across consumers serve to promote
efficiency.
Explain the mathematics behind efficiency in exchange.
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.
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Economic Efficiency
With regard to exchange, economic efficiency represents a
distribution of goods across consumers in which no one
consumer can be made better off without hurting another
consumer.
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Understand why voluntary exchange is mutually beneficial.
6.1 TWOPERSON EXCHANGE
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TwoPerson Exchange
People engage in exchanges (or trades) because they expect
to benefit.
Voluntary exchange is mutually beneficial, assuming that
Fraud has not taken place.
Benefit: expectations at the time of the transaction
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Table 6.1
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The Edgeworth Exchange Box Diagram
Edgeworth exchange box: a diagram for examining the
allocation of fixed total quantities of two goods between
two consumers.
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Figure 6.1 Edgeworth Exchange Box
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The Edgeworth Exchange Box with
Indifference Curves
Indifference curves:
Negatively sloped
Convex
Curves farther from the origin are preferred to those
closer to the origin
Indifference map – shows entire preference mapping
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Figure 6.2 – Gains from Trade
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Gains from Trade
Every point inside the shaded area: a market basket for each
consumer that is preferred to Basket A (Figure 6.2)
Where the marginal rates of substitution differ: mutually
beneficial trade between the parties is possible.
Final outcome is not uniquely determined.
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Explain what economists mean by efficiency in exchange and the benefits
associated with the promotion of such efficiency.
6.2 EFFICIENCY IN THE
DISTRIBUTION OF GOODS
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Efficiency in the Distribution of Goods
Pareto optimality – another term for economic efficiency: an efficient
distribution of fixed total quantities of goods such that it is not possible, through
any change in the distribution, to benefit one person without making some other
person worse off.
Contract curve – in an Edgeworth exchange box, a line drawn through all the
efficient distributions
Inefficiency – an allocation of goods in which it is possible, through a change in
the distribution, to benefit one party without harming the other
Equity – the concept of fairness
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Figure 6.3 Efficient Distributions and
the Contract Curve
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Efficiency and Equity
Initial Endowment: determines which efficient points on
the contract curve at attainable though voluntary exchange
Fairness requires normative considerations which are
subjective judgments
Pareto optimality cannot help make normative judgments.
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Discuss how competitive markets promote efficient distribution of goods
between consumers.
6.3 COMPETITIVE EQUILIBRIUM AND
EFFICIENT DISTRIBUTION
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Competitive Equilibrium and Efficient
Distribution
Price taker – firms or consumers who cannot affect the
prevailing price through their respective production and
consumption decisions
Adam Smith’s “invisible hand”: each trader, concerned
only with furthering his or her own interest, is led to
exchange to a socially efficient result
Competitive market:
Final equilibrium point is an efficient allocation
All potential gains are realized from voluntary exchange
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Figure 6.4 Competitive Exchange
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Competitive Equilibrium and Efficient
Allocation
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Figure 6.5 A MarketDetermined
Distribution is Efficient
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Explore the extent to which price and nonprice mechanisms for rationing
goods across consumers serve to promote efficiency.
6.4 PRICE AND NONPRICE
RATIONING AND EFFICIENCY
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Price and Nonprice Rationing and Efficiency
Demand curve treatment of rationing problems
In an open market, prices serve as rationing function.
Result: efficient distribution of goods
Alternative to the Edgeworth box approach
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Figure 6.6 – Gasoline Rationing
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Explain the mathematics behind efficiency in exchange.
6.5 SOME OF THE MATHEMATICS
BEHIND EFFICIENCY IN EXCHANGE*
*Denotes digitalonly content
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Some of the Mathematics behind Efficiency
in Exchange
“Efficient distribution” (interpretations)
One that makes one consumer as well off as possible for
a given level of wellbeing for the other consumer
One that maximizes the utility of one consumer subject
to the constraint that the utility of the other is held fixed
at some level
Efficient distribution is attained when:
Consumers’ indifference curves in the Edgeworth
diagram are tangent
The consumers’ MRSs are equal
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