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The Edgeworth Box

The document discusses the Edgeworth Box, which is a graphical model that represents preferences and consumption possibilities for two individuals and two goods. It can be used to analyze exchange and markets. The box is formed by overlaying the individuals' indifference curves. Points inside the box indicate different distributions of goods between the individuals. Pareto optimal points occur where the indifference curves are tangent, meaning no change can make one individual better off without making the other worse off. The budget line represents the maximum amount of goods each individual can attain given prices and income. At Pareto optimal points, the marginal rate of substitution between goods equals the negative price ratio.

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sudhirkale
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386 views

The Edgeworth Box

The document discusses the Edgeworth Box, which is a graphical model that represents preferences and consumption possibilities for two individuals and two goods. It can be used to analyze exchange and markets. The box is formed by overlaying the individuals' indifference curves. Points inside the box indicate different distributions of goods between the individuals. Pareto optimal points occur where the indifference curves are tangent, meaning no change can make one individual better off without making the other worse off. The budget line represents the maximum amount of goods each individual can attain given prices and income. At Pareto optimal points, the marginal rate of substitution between goods equals the negative price ratio.

Uploaded by

sudhirkale
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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The Edgeworth Box

and
Pareto Optimal

Presented By:
Sudhir Kale.
MITCON Institute of
management, Pune.
The Edgeworth Box

 Francis Edgeworth developed the


method of analysis in the last
portion of the 19th century.
 Provides a powerful way of
graphically studying exchange and
the role of markets.
 Understanding the Edgeworth Box is
critical to understanding exchange
and markets.
 The modern version of diagram is
commanly referred to as
How To Form an
Edgeworth Box

 Rotateone of the graphs onto the


other one until it forms a box.
Consider two
consumers
and two products
y1 y2

y1 y1
0 0
x1 x1 x2
x1
The Edgeworth Box

y1
0
x1

y1
0
x1
The Edgeworth Box

y1
0
x1

y1
0
x1
The Edgeworth Box

y1
0
x1

y1
0
x1
The Edgeworth Box

y1
0
x1

x1
y1
0
The Edgeworth Box

0 x1
y1
y1
0
x1
The Edgeworth Box

x1
0
y1

y1
0
x1
Pareto Optimal

 When no change can make one


better off without making the other
worse off.
 With general equilibrium of
production & exchange, economic
efficiency is maximum & we have
Pareto Optimal.
 According to this concept, a
distribution of inputs among
commodities & of commdities
The Edgeworth Box
x2
III1 II1 I1

y2

A is the
equilibrium point
where pareto
optimum occuring.

C 2
II 1
y1
I 2 I 12
II
x1
The Edgeworth Box
x2
IV2 III2 II2 I2

B y2

E”
E’
Contract line
Which is locus of a
Pareto optimals.
A
E

C
y1

I1 II1 III1 IV1


x1
Understanding the
Picture
 Any point in the Edgeworth box
indicates a particular distribution of
the two goods among the two
individuals, e.g. A and B.
 Each individual has an indifference
curve going through that point.
 If the distribution is Pareto optimal,
those two indifference curves are
tangent at that point.
The Edgeworth Box
x2
III2 II2 I2

B y2

E”

E’

A
Price or budget
E line

C
y1

I1 II1 III1
x1
Tangent line is really a
budget line for both
individuals
 Ifone extends the tangent line to
each axis, we now have a budget
line.
 For example, the budget line for 1st
individual is where I is the income
that person get from selling the X
and Y he/she holds at the Pareto
optimum point.
Income/pri
ce of y
Budget Line

C Price or budget
line
y

x Income/p
rice of
x
Marginal Rate of
Substitution
Income /Py

Slope of indifference curve gives


the marginal rate of substitution

Price or budget
line
y

x Income /Px
MARGINAL RATE OF
SUBSTITUTION

m arg inal utility of x


MRS xy =
M arg inal Utility of x
MRS =

m arg inal utility of y


At point D

 Slope of indifference curve equals


the slope of the budget line or
 MRSxy = -Px/ Py
Feedback @ [email protected]

THANK YOU

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