Edgeworth Box: Analysis of General Equilibrium

This article discusses the Edgeworth Box and its role in the analysis of general equilibrium. It explains how the box allows for the study of exchange behavior between individuals trading different goods. The article also explores the limitations of the traditional demand and supply framework and how the Edgeworth Box extends the analysis to multiple markets. Additionally, it discusses the concept of initial endowment and the determination of equilibrium quantities and prices.

QUESTIONS AND ANSWERS 1
EDGEWORTH BOX
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QUESTIONS AND ANSWERS 2
Question 1: (8 marks)
Overview
Basically, the study of market behaviors is done using the traditional demand and
supply framework. Through this framework, economists are able to determine both the
equilibrium quantities and prices in different types of markets. This framework, however, has
some limitations and that’s why it’s seen as a partial equilibrium analysis. This is because it
looks at quantity and price determinants of products in just a single market while holding the
rest of the markets constant.
Edgeworth box
To take care of the above shortcoming in determining the equilibrium analysis,
general equilibrium analysis is utilized because it extends the analysis of demand and supply
in a number of markets. Edgeworth box is the main tool used in the analysis of general
equilibrium because it allows people to study the dealings between two individuals trading
with two totally different goods (Amar-Sabbah and Batteau, 2018, p.11). This analysis
utilizes an indifference curve technique to examine exchange behavior.

QUESTIONS AND ANSWERS 3
Emma is denoted by the origin (Oa) of the lower left-hand corner of the above
diagram while her partner Theo is denoted in the origin (Ob) of upper right-hand
corner. Emma’s indifference curve is the convex to point OA while Theo’s is the convex to
point OB. Moving to the right-hand side denotes that Emma produces more coffee and which
Theo produces less of it (Brauer and Gissy, 2017, p.55). Going upwards denotes that Theo
has more of Tea and which Emma has less. For that matter, when moving on the northeast
direction Emma is better off compared to Theo while moving on the southwest direction,
Theo is better off than Emma.
Question 2: (8 marks)
Instead of introducing budget lines for Emma and Theo, the Edgeworth box has used
the initial endowment concept where the initial endowment denoted by “w” as shown in the
diagram has represented the total amount of coffee and tea which Emma and Theo had before
the trade. Therefore (XA ,YA) = wA while (XB , YB ) = wB where wA and wB represent
Emma’s initial endowment(income) and Theo’s initial endowment (income) respectively.

QUESTIONS AND ANSWERS 4
Edgeworth box’s height is simply the average amount of Tea available while its width is the
total amount of Coffee available. Without any additional production of coffee and tea, the
box’s dimensions remains constant (Barker, 2016, p.255).
The main aim of using general equilibrium in the analysis is to determine whether it’s
conceivable to make Emma and or/ Theo better off by the process of exchange given an
initial endowment. For instance in a trade deal where Emma and Theo approach point R in
the above diagram, Theo will be better off without harming Emma. On the other hand, any
trade putting Emma and Theo near the border or inside the shaded region will make either
Emma, Theo or both of them better off. This is referred to as a Pareto Improvement and as
long as it exists, incentives for trade must exist between the two agents (Bimonte and Punzo,
2016, p.128).
Question 3: (8 marks)
This is because despite having a Pareto Efficient Allocation, the equilibrium achieved
by the set of prices for both Emma and Theo is not always the competitive or market
equilibrium and mainly favors one of the agents. This draws from the fact that as long as

QUESTIONS AND ANSWERS 5
agent preferences are convex there will always be an equilibrium point. This draws from the
second welfare economics which states that: If all the agents have a convex preference, then
there is always a set of prices in that each Pareto Efficient Allocation is market equilibrium
for all the appropriate assignment of endowments (Creedy, 2017, p.1).
Question 4: (8 marks)
As seen in the diagram above, a subjective set of prices (p1, p2) does not guarantee
that the demand (the aggregate demand for both Emma and Theo) balances with the supply
(Emma’s endowment of Coffee and Theo’s endowment of Tea). That denotes the excess
demand of A (B) e I A = xi A − ω i A (e i B = xi B − ω i B), and where i ∈ 1, 2, must not be
what the other person B(A) anticipates to sell.

QUESTIONS AND ANSWERS 6
In terms of cumulative demand of Emma and Theo, the average demand must not be
equalize the total endowment of both Coffee and Tea. In that case, the diagram above
indicates that the market is in disequilibrium. This is in consideration to the fact that under
equilibrium state, the budget line crosses the endowment point predominantly because the
returns of any of the two agents (Emma and Theo) is determined by their individual
endowment.
Question 5: (8 marks)
The proceeding step in the analysis of general equilibrium involves the determination
of the changes right from the initial endowment to the Pareto efficient allocation. The
movement has been achieved through a price system that involves the relative price between
coffee and tea and which represents the terms of trade between Emma and Theo. A slope of
all the lines passing through endowment point represents the ratio of coffee price to that of
tea (Rubinstein and Wolinsky, 2018, p.111). Therefore, if any line is relatively steep, it
implies that coffee is comparatively more costly than tea but if the line is comparatively flat,
then tea is relatively more expensive than coffee. Finally, through a hypothesized auction

QUESTIONS AND ANSWERS 7
process, the market equilibrium is established at the Pareto Optimum, where: MRSAxy =
(MUiX / MUiY) = MRSBxy = (Px / Py) for i = A,B
References
Amar-Sabbah, A. and Batteau, P., 2018. CEO Compensation: Agency Theory is Irrelevant
but not the Neoclassical Game-Theoretic Framework. The New Palgrave Dictionary of
Economics, pp.11-211
Brauer, J. and Gissy, W.G., 2017. The Economics of Conflict and Peace. Practicing
Professional Ethics in Economics and Public Policy (pp. 55-63)Taylor & Francis.
Barker, D.K., 2016. Ethics and Social Justice. In Practicing Professional Ethics in Economics
and Public Policy (pp. 255-263). Springer, Dordrecht.
Bimonte, S. and Punzo, L.F., 2016. Tourist development and host–guest interaction: An
economic exchange theory. Annals of Tourism Research, 58, pp.128-139.
Creedy, J., 2017. Edgeworth, Francis Ysidro (1845–1926). The New Palgrave Dictionary of
Economics, pp.1-21.
Rubinstein, A. and Wolinsky, A., 2018. Biased Preferences Equilibrium. The New Palgrave
Dictionary of Economics, pp.111-121.