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a blog from young economists at Nova SBE

Microeconomics´problem sets and the pure exchange economy

One possible interesting application of the general equilibrium on pure exchange economy that we had covered on Microeconomic Policy course deals with the resolution of our problem sets.

Firstly, it is important to mention what are the main assumptions under the pure exchange economy. Therefore, we assume individuals as price takers, absence of production or government,  a closed economy and the individuals will consume and have initial endowments that are exogenous. Furthermore, based on Edgeworth box, which dimensions are plotted according with feasible allocations, that is the total amount of endowments of each good, we know that , individuals will always agree to an exchange which makes at least one of them better off and the other no worse off and neither individual will ever agree to an exchange which makes him or her worse off ( the called Edgeworth Hypothesis).  That means, under the existence of Pareto moves, individuals will trade and have mutual beneficial gains. When they achieve competitive equilibrium or Pareto efficient allocations – set of allocations on contract curve they will be better than initial situation and will not trade more, because all the possibilities of at least one become better off without the other to become worse off were exhausted .

I just tried to imagine how much we can gain from exchange with each other’s solutions or ideas of our problem sets and actually we know that we will stop trading when we have the correct answers for all questions. I also realised that if we consider a group of students with different comparative advantages, for instance ones are better on derivatives and mathematical issues, others with theoretical framework and concepts , others with graphical representation and others even with the ability to identify mistakes or that have perfect English , if we trade, the outcome would be surely beneficial for everybody. I mentioned comparative advantages, since that according with  David Ricardo they are a source of trade. Individual can specialize on what they are relatively more efficient and have gains from trading with others.

 In our case, let´s suppose that each student have the same number of questions, but different number of solved and/or incomplete questions. The initial endowments for each student are, thus different, in what concerns the number of questions solved. The preferences can be different from individual to individual. If trade takes place and assuming the comparative advantages, Pareto moves will remain until the expected outcome is reached, that means all students have the same answers to all questions of the problem set, due to the exchange of several and different ideas and knowledge. ( MRS are the same among them). And these mutually beneficial gains can also be expressed later on, in the sense that, students can understand issues that they could not  notice alone or they can improve details that were not so well done – that is positive externalities.

One question that can be raised is the fact that we are trading a public good, in the sense that the knowledge in general is not restricted to anybody. The fact that one consumer consumes it does not impede the other to consume it as well. For instance, if two individuals have one idea each and they trade between them, each of them gets two ideas.  The question is, how many ideas do we want to have in order to solve the problem set?  In other words, what is the optimal number of ideas?

Therefore, to deal with a general equilibrium with public goods it is reasonable to assume that, concerning the problem set, there is only a correct answer to each question. That means, that if individuals trade ideas or may have different kind of knowledge (theoretical, mathematical) to solve the questions, they should achieve an agreement  in order to provide the correct answer. This agreement will be Pareto efficient, since it will mix all the ideas and the possibilities of trade are exhausted. The Knowledge of the group should be the necessary one to find the correct and unique solution to each question. Moreover, the time constraint is important, in the sense that the students should be able to complete the task until the deadline date.  And given the comparative advantages, students can be bad or good, but at the end, due to trade, they should derive a single solution to each question of the problem set.

Lets going to wait for feedback on our group work for the 3rd problem set.


 Marta Caeiro, 632

Author: studentnovasbe

Master student in Nova Sbe

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