INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 1

Edgeworth Box

0 LaborX LX

CapitalX KX

Suppose we look at the production possibilities for good X

Then this may represent an isoquant for good X (e.g. combinations of capital and labour producing 1 X)

Similarly, this may be another isoquant for good X (e.g. producing 1.5 X)

X=1

X=1.5

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 2

0 LabourY LY

CapitalY

KY

We might, however, also use our capital and labour to produce

Something else, say good Y. Just as with good X we

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=2

Y=3

Edgeworth Box

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 3

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

0 LX

KX

0 LY

KY

Edgeworth Box

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 4

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

Edgeworth Box

0 LX

KX

0 LY

KY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 5

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

Edgeworth Box

0 LX

KX

0

L Y

K Y

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 6

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

Edgeworth Box

0 LX

KX

0

LY

KY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 7

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

Edgeworth Box

0 LX

KX

0LY

KY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 8

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

Edgeworth Box

0 LX

KX

0LY

KY

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 9

The origin of good X is in the south-west corner

Lx

Kx

Ox

Ly

Ky

Oy

A

The origin of good Y is in the north-east corner

Lx and Kx are measured relative to the Ox corner

Ly and Ky are measured relative to the Oy corner

Edgeworth Box

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 10

Lx

Kx

Ox

Ly

Ky

Oy

L

KWe 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

This follows from the upper contourset of good Y at point A

A

Edgeworth Box

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 11

Lx

Kx

Ox

Ly

Ky

L

K

A

Moving K from X to Y and L from Y to X

The combination of all efficient input allocations is called the

contract curve

Edgeworth Box

Can increase the production of X without lowering the prod. of Y

Oy

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY; Charles van Marrewijk, 2006; 12

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).

X

Y

Otherwise, the ppf is a strictly function, that is take 2

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 that is all points in between 2 arbitrary points that can be produced can also be produced

A

B

concave

convex,

Edgeworth Box