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Market Equilibrium and The Core: Ram Singh

The document discusses competitive equilibrium and the core in a 2x2 economy. It shows that: 1) For a 2x2 economy, if an allocation is a competitive equilibrium, it is also in the core. 2) More generally, it proves that for any exchange economy with monotonic preferences, every competitive equilibrium allocation is Pareto optimal and belongs to the core. 3) It discusses the first fundamental theorem of welfare economics, which states that every competitive equilibrium allocation is Pareto optimal.

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Shreya Jain
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17 views

Market Equilibrium and The Core: Ram Singh

The document discusses competitive equilibrium and the core in a 2x2 economy. It shows that: 1) For a 2x2 economy, if an allocation is a competitive equilibrium, it is also in the core. 2) More generally, it proves that for any exchange economy with monotonic preferences, every competitive equilibrium allocation is Pareto optimal and belongs to the core. 3) It discusses the first fundamental theorem of welfare economics, which states that every competitive equilibrium allocation is Pareto optimal.

Uploaded by

Shreya Jain
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
You are on page 1/ 9

Market Equilibrium and the Core

Ram Singh

Lecture 4

Ram Singh (DSE) Market Equilibrium 1/9


Competitive Equilibrium and Core: 2 × 2 Economy I

Assume ‘well-behaved’ utilities. In that case,


at the equilibrium allocation, x̂ = (x̂1 , x̂2 ),
the ICs are tangent to each other
Therefore, the equilibrium allocation x̂ = (x̂1 , x̂2 ) is Pareto Optimum.

Question
Suppose, x̂ = (x̂1 , x̂2 ) is a Competitive (market) equilibrium allocation
Are unilateral deviations from x̂ = (x̂1 , x̂2 ) profitable?
Can a subgroup profitably deviate from x̂ = (x̂1 , x̂2 ) ?
Does the eq. allocation x̂ = (x̂1 , x̂2 ) belong to the core?

Ram Singh (DSE) Market Equilibrium 2/9


Competitive Equilibrium and Core: 2 × 2 Economy II

For a 2 × 2 economy, suppose an allocation x̂ = (x̂1 , x̂2 ) along with a price


vector p = (p1 , p2 ) is competitive equilibrium. Then,

Individual i prefers xi at least as much as ei


Indifference curves of the individuals are tangent to each other
Allocation x̂ = (x̂1 , x̂2 ) is Pareto Optimum
In view of the above, allocation x̂ = (x̂1 , x̂2 ) is in the Core.

Ram Singh (DSE) Market Equilibrium 3/9


Competitive Equilibrium and Core: 2 × 2 Economy

Ram Singh (DSE) Market Equilibrium 4/9


Competitive Equilibrium and Core I

Let

W (u i (.), ei )N×M denote the set of Walrasian/competitive allocations.


C(u i (.), ei )N×M denote the set of Core allocations.

We know that for a 2 × 2 economy,

x ∈ W (u i (.), ei ) ⇒ x ∈ C(u i (.), ei ).

Theorem
Consider an exchange economy (u i (.), ei )N×M , where individual preferences
are monotonic, i.e., u i is increasing. If x is a WEA, then x ∈ C(u i (.), ei )N×M .
Formally,
W (u i (.), ei )N×M ⊆ C(u i (.), ei )N×M .

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Competitive Equilibrium and Core II
Proof: Take any x WEA. Let, x along with the price vector p be a WE.
Suppose
x 6∈ C(e).
Therefore, there exists a ‘blocking coalition’ against x. That is,
there exists a set S ⊆ N and an ’allocation’ say y, s.t.
X X
yi = ei (1)
i∈S i∈S

Moreover,
u i (yi ) ≥ u i (xi ) for all i ∈ S (2)
and for some i 0 ∈ S 0 0
u i (yi ) > u i (xi ). (3)
(1) implies
X X
p. yi = p. ei (4)
i∈S i∈S

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Competitive Equilibrium and Core III

(2) implies
p.yi ≥ p.xi = p.ei , for all i ∈ S (5)
(3) implies: for some i 0 ∈ S
0 0 0
p.yi > p.xi = p.ei . (6)

(5) and (6) together give us:


X X
p. yi > p. ei (7)
i∈S i∈S

But, (4) and (7) are mutually contradictory. Therefore,

x ∈ C(e).

Ram Singh (DSE) Market Equilibrium 7/9


Competitive Equilibrium and Pareto Optimality

So, we have proved the First Fundamental Theorem of Welfare Economics:

Theorem
Consider an exchange economy (u i , ei )i∈{1,..,N} , where u i is strictly
increasing, for all i = 1, .., N.

Every WEA is Pareto optimum.

Ram Singh (DSE) Market Equilibrium 8/9


Competitive Equilibrium: Merits and Demerits

Question
Is the price/market economy better than the barter economy, in terms of
its functioning?
Is the price/market economy better than the barter economy, in terms of
the outcome achieved?

Question
What are the limitations of a market economy?
Can these limitations be overcome?

Ram Singh (DSE) Market Equilibrium 9/9

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