Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

Check your progress
1. Explain the conditions of existence of general equilibrium 
2. Define Partial equilibrium analysis. 
3. Define General equilibrium analysis. 
 
 
 
 
 
 
 
 
 
5.4 GENERAL EQUILIBRIUM OF EXCHANGE AND 
PRODUCTION 
 
In this section, we examine separately general equilibrium of 
exchange and of production, and we derive the production-
possibilities frontier.
5.4.1 General Equilibrium of Exchange 
Let us begin by examining general equilibrium of exchange 
for a very simple economy composed of only two individuals (A and 
B), two commodities(X and Y), and no production. This allows us to 
present the general equilibrium of exchange graphically.

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0
1
2
3
4
5
6
7
8
1
2
3
4
5
6
7
8
9
Commodity X
C
o
m
m
o
d
it
y
 Y
FIGURE 5.2: EDGEWORTH BOX DIAGRAM FOR EXCHANGE 
In the above figure, the indifference curves of individual A, 
convex to origin 0
A
, are given by A
1
, A
2
, and A
3
and the indifference 
curves of individual B, convex to origin 0
B
, are given by B
1
, B
2
, and 
B
3
. The dimensions of the box are given by the total amount of the 
two commodities (10X and 8Y) owned by the two individuals 
together. Any point inside the box indicates how the total amount of 
the two commodities is distributed between the two individuals. For 
example, point C indicates that individual A has 3X and 6Y, while 
individual B has 7X and 2Y, for the combined total of 10X and 8Y. 
Suppose that point C does in fact represent the original distribution 
of commodities X and Y between individuals A and B. since at point 
C, indifference curve A
1
and B
1
intersect, their slope or marginal 
rate of substitution of commodity X for commodity Y (MRS
XY
) 
differs. Starting at point C, individual A is willing to give up 4Y to get 
one additional unit of X (and move to point D on A
1
), while 
individual B is willing to accept 0.2Y in exchange for one unit of X 
(and move to point H on B
1
). Because A is willing to give up much 
more Y than necessary to induce B to give up 1X, there is a basis 
for exchange that will benefit either or both individuals. This is true 
whenever, as at point C, the MRS
XY
for the two individuals differs.