Chapter 16,General Equilibrium and Economic Efficiency,Chapter 16,2,Topics to be Discussed,General Equilibrium Analysis Efficiency in Exchange Equity and Efficiency Efficiency in Production,Chapter 16,3,Topics to be Discussed,The Gains from Free Trade An Overview: The Efficiency of Competitive Markets Why Markets Fail,Chapter 16,4,General Equilibrium Analysis,Up to this point, we have been focused on partial equilibrium analysis Activity in one market has little or no effect on other markets Market interrelationships can be important Complements and substitutes Increase in firms input demand can cause market price of the input and product to rise,Chapter 16,5,General Equilibrium Analysis,To study how markets interrelate, we can use general equilibrium analysis Simultaneous determination of the prices and quantities in all relevant markets, taking into account feedback effects The feedback effect is the price or quantity adjustment in one market caused by price and quantity adjustments in related markets,Chapter 16,6,Two Interdependent Markets Moving to General Equilibrium,Scenario The competitive markets of: DVD rentals Movie theater tickets These goods are substitutes Changing prices in one market are likely to affect the other market,Chapter 16,7,Two Interdependent Markets Moving to General Equilibrium,Scenario Equilibrium price of movies is $6.00 Equilibrium price of DVD rentals is $3.00 Government places a $1.00 tax on each movie ticket Need to look at effect of tax on Market for DVDs Feedback effects in movie market,8,Two Interdependent Markets Movies and DVDs,Price,Number of Videos,Price,Number of Movie Tickets,$1 tax on each movie ticket causes supply to fall,General Equilibrium Analysis: Increase in movie ticket prices increases demand for videos.,Chapter 16,9,Two Interdependent Markets Movies and DVDs,Price,Number of Videos,Price,The increase in the price of videos increases the demand for movies.,General Equilibrium Analysis: The Feedback effects continue.,Chapter 16,10,Two Interdependent Markets Movies and DVDs,Observation Without considering the feedback effect with general equilibrium, the impact of the tax would have been underestimated This is an important consideration for policy makers You can check for yourself that in the market for complements, the tax would be overestimated,Chapter 16,11,Reaching General Equilibrium,Must be able to determine the equilibrium price of both movies and DVDs simultaneously We must simultaneously find two prices that equate quantity demanded and quantity supplied in all related markets The requires finding the solution to four equations: demand and supply for DVDs and movies,Chapter 16,12,The Interdependence of International Markets,Brazil and the United States compete in the world soybean market, so one market can affect the other Brazil limited exports of soybeans in the late 1960s and early 1970s, causing price in Brazil to fall Eventually the export controls were to be removed, and Brazilian exports were expected to increase,Chapter 16,13,The Interdependence of International Markets,Expectation was based on partial equilibrium analysis Program actually increased the price and production of soybeans in US as well as US exports This caused Brazil to have difficulties exporting even after control was removed Can show how each market was affected and compare to general equilibrium analysis,14,Soybean Exports Brazil and US,Chapter 16,15,Efficiency in Exchange,We showed before that competitive markets are efficient because consumer and producer surpluses are maximized We can study this in more detail by examining an exchange economy Market in which two or more consumers trade two goods among themselves Same for two countries,Chapter 16,16,Efficiency in Exchange,An efficient allocation of goods is one where no one can be made better off without making someone else worse off Pareto efficiency Voluntary trade between two parties is mutually beneficial and increases economic efficiency,Chapter 16,17,The Advantages of Trade,Assumptions Two consumers (countries) Two goods Both people know each others preferences Exchanging goods involves zero transaction costs James and Karen have a total of 10 units of food and 6 units of clothing,Chapter 16,18,The Advantage of Trade,To determine if they are better off, we need to know the preferences for food and clothing,Chapter 16,19,The Advantage of Trade,Karen has a lot of clothing and little food MRS of food for clothing is 3 To get 1 unit of food, she will give up 3 units of clothing James MRS of food for clothing is only He will give up unit if clothing for 1 unit of food,Chapter 16,20,The Advantage of Trade,There is room for trade James values clothing more than Karen Karen values food more than James Karen is willing to give up 3 units of clothing to get 1 unit of food, but James is willing to take only unit of clothing for 1 unit of food Actual terms of trade are determined through bargaining Trade for 1 unit of food will fall between and 3 units of clothing,