INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 1

Edgeworth Box Suppose we look at the production possibilities for good X Then this may represent an isoquant for good X (e.g. CapitalX combinations of capital and labour producing 1 X) KX Similarly, this may be another isoquant for good X (e.g. producing 1.5 X)

X=1.5 X=1 0 LaborX LX

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 2

Edgeworth Box

We might, however, also use our capital and labour to produce Something else, say good Y. Just as with good X we CapitalY KY can draw combinations of inputs, capitalY and labourY, to produce a certain level of good Y. For example, the isoquants Y=2 and Y=3 in this figure.

Y=3 Y=2 0 LabourY LY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 3

Edgeworth Box Combining these two possibilities the figure on the left represents isoquants for good X and the figure on the right isoquants for good Y

KX

KY

LX

LY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 4

Edgeworth Box We can combine the information of these two figures into one figure

KX

KY

LX

LY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 5

Edgeworth Box We can combine the information of these two figures into one figure

KX

LX

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 6

Edgeworth Box We can combine the information of these two figures into one figure

KX

LX

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 7

Edgeworth Box We can combine the information of these two figures into one figure

KX

LX

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 8

Edgeworth Box We can combine the information of these two figures into one figure 0 LX KY LY KX 0

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 9

Edgeworth Box Kx Ly The origin of good X is in the southwest corner Oy The origin of good Y is in the northeast corner

A Ly and Ky are measured relative to the Oy corner

Lx and Kx are measured relative to the Ox corner Ox

Ky Lx

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 10

Edgeworth Box

Kx K

Ly

Oy
We let K be the available capital and L the available labor Point A is not an efficient allocation of K and L for the production of X and Y Lx

Ox

This follows from the upper contour set of good Y at point A

Ky L

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 11

Edgeworth Box Kx K Moving K from X to Y and L from Y to X Can increase Ly Oy the production of X without lowering the prod. of Y The A combination of all efficient input allocations is called the

contract curve
Ky Ox

Lx

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;

Charles van Marrewijk, 2006; 12

Edgeworth Box To test whether you understand the Edgeworth Box and the properties of CRS try to derive the special circumstances under which the ppf is a straight line (there are two distinct special cases). Otherwise, the ppf is a strictly concave function, that is take 2 Y arbitrary points on the ppf, such as A and B in the figure Connect them with the red straight line, then the value of the ppf must be everywhere above this red straight line

As a consequence the production possibility set is convex, that is all points in between 2 arbitrary points that can be produced can also be produced
B X