Asked by Brayan Patlan on Jul 12, 2024
Verified
Consider a potential, voluntary exchange between two people. Assume that both people have complete information about each other's preferences and that there are no transaction costs. Consumers A and B have between them 9 units of X and 15 units of Y. Initially, A has 6 of X and 10 of Y, and B has 3 of X and 5 of Y. Consumer A's marginal rate of substitution of X for Y is 2 and B's marginal rate of substitution of X for Y is 1/3. Is there room for a mutually beneficial, voluntary exchange? Determine which consumer would trade for more X and which consumer would trade for more Y. If trade takes place, can you explain the terms of trade?
Voluntary Exchange
A transaction where two parties mutually agree to trade goods, services, or resources, typically to the perceived benefit of both.
Marginal Rate
The rate of change in cost, output, or benefit as a result of a one-unit increase in an input.
- Examine situations regarding trade between individuals to detect exchanges that are advantageous for both parties.
- Explain the function of market prices in establishing competitive equilibrium and ensuring efficient distribution.
Verified Answer
AE
Ashley EnríquezJul 13, 2024
Final Answer :
To get one more unit of X, A is willing to give up at most two units of Y. To give up one unit of X, B needs to get at least 1/3 of a unit of Y. Thus, a mutually beneficial exchange can be made. A would trade to get more X and B would trade to get more Y, and both would be better off. The terms of trade depend upon the bargaining process but will be between 2 and 1/3. The amounts traded are determined by a point at which the two MRS are equal.
Learning Objectives
- Examine situations regarding trade between individuals to detect exchanges that are advantageous for both parties.
- Explain the function of market prices in establishing competitive equilibrium and ensuring efficient distribution.