Consider an exchange economy with two consumers, Jack and Blue, who trade only two goods: Cookies and Hats. Quantities of Cookies are measured vertically, and quantities of Hats are measured horizontally. Jacks origin should be placed at the bottom left. a. 1. Draw an Edgeworth box diagram in which the two consumers can exchange the two goods. Show at least three indifference curves for each consumer. These curves should be well spread across the Edgeworth box. Label and briefly explain the Indifference curves and origins for Jack and Blue b. On a copy of your diagram, show and label the contract curve. By referring to the concept of Pareto efficiency, explain its economic significance. Also show and explain the core of this exchange economy.
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Follow up questions:
1.
Using a new box diagram for Jack and Blue, mark a possible initial endowment point and, with the help of a budget constraint line and indifference
2.
Reproduce the diagram you used for Q2 and explain what must happen to the price of Hats relative to the price of Cookies for equilibrium to be established, eliminating the excess demand for Hats. Show this on your diagram and explain the adjustment process and equilibrium outcome in full.
3.
Discuss in full the implications for efficiency and fairness of the First Welfare Theorem and the Second Welfare Theorem