|
|||
|
Exhibition: The perfect market
economy 1 Introduction The
perfect market economy model from introductory microeconomics is presented in
a concise and graphical way (This exhibition
was made by inspiration from Nicholson, W. [1979], Markusen, J. H. [1988],
and Bohm, P. [1987]). The exhibition proceeds as follows. First the pure
consumption economy is illustrated. Then the pure production economy is
explained, and finally it presents the combined production and consumption
economy. 2 The
Consumption Model Model assumptions The
assumptions underlying the perfect market economy model are often not made
explicit. The following presents a list of the general assumptions.
Additional assumptions follow. 1.
Utility maximization
(opportunism). 2.
Perfect rationality
(Strong-form rationality). 3.
Firms maximize
profit (Strong-form efficiency). 4.
Preferences are
transitive and stable. 5.
Perfect competition
(Price taking agents). 6.
Perfect information. 7.
Certainty. 8.
No externalities
(e.g. no pollution, no network externalities, no look-ins). 9.
No asset specificity
i.e. no quasi rents. 10.
No public goods. 11.
Separability of
production. 12.
No economics of
scale and scope. 13.
No connectedness of
exchange. 14.
No distortions (e.g.
taxes). 15.
Homogeneous goods. 16.
No direct transaction
cost. 17.
All property is
privately held. 18.
Human capital can be
sold (Slavery is legal). 19.
All assets are
priced and traded in markets. 20.
All utility can be
measured in pecuniary terms. 21.
No measurement
problems. 22.
No crime or war and
litigation is does not cost anything. 23.
Time is static. 24.
All exchange is
voluntary. |
|||
|
|
|||
|
Additional
assumptions 1.
The economy is a
pure exchange economy (no production, all resources is initially given) with
two consumers Sam and Jim (easily generalized to a multiple of consumers). 2.
Two commodities is
exchanged; X, Y (easily generalized to a multiple of commodities). 3.
Sam and Jim has
utility functions; US=US(X,Y) and UJ=UJ(X,Y), where U’S
>0, U’J >0 and U’’S < 0, U’’J < 0 for both commodities. That is, both commodities are perceived
as goods because the first derivatives are positive, but the utility function
exhibit diminishing marginal utility because the second derivatives are
negative. It can be proved that this will yield a smooth and concave preference
curve, which is necessary for existence of a unique equilibrium. 4.
Each person knows
how to rank alternative commodity combinations available to him. 5.
All indifference
curves are convex to the origin, that is, U(.) is convex. 6.
Utility is measured
ordinal not cardinal. 7.
The economy has no
institutions (monetary system, legal system, government etc.). Or the institutions
exist but are irrelevant because they work perfect at no cost. 8.
There are no changes
in society that may affect preferences. 3 The Production Model Figure
2 presents the box diagram and it is conceptually identical to the above
Edgeworth Box. However, the interpretation and some of the assumptions are
slightly changed. |
|||
|
|
|||
|
Additional assumptions 1.
The economy is a
pure production economy (no consumption, all factors of production is
initially given) with two producers Sam and Jim (easily generalized to a
multiple of producers). 2.
Two commodities is
exchanged; X, Y (easily generalized to a multiple of commodities). 3.
Sam and Jim has
production functions; X=FS(X,Y) and Y=FJ(X,Y), where F’S
>0, F’J >0, and F’’S < 0, F’’J < 0 in both arguments. That
is, factors are always productive but at a decreasing rate or both producers
are subject to decreasing return to scale. It can be proved, that this will
yield a smooth concave production possibility curve, which is necessary for
existence of a unique equilibrium. 4.
Producers know their
F and will therefore always produce in an efficient way. 5.
All isoquant curves
are convex to the origin, that is, F(.) is convex. 6.
Production [X,Y] is
measured cardinally. 7.
The economy has no
institutions (monetary system, legal system, governments etc.). Or the institutions
exist but are irrelevant because they functions perfect at no cost. 8.
There are no changes
in society that may affect preferences. 4 Efficiency
in Production and Exchange Figure 3 below is the final graph
illustrating the general equilibrium economy including production and
consumption. No further assumptions are needed if the figure is interpreted
as a Robinson Crusoe economy. This economy only has one agent; Robinson who
produces his own consumption. All the above mentioned assumptions remain
unchanged. The more general interpretation is one with multiple commodities,
consumers, and producers. In this case all the above assumptions are needed.
Again they must be corrected for the fact that that there are more than two
commodities, producers and consumers. In figure 3, X and Y may be considered
as bundles of commodities and services. Unfortunately, we need a few more
assumptions in order to aggregate the utility functions into community indifference
curves. Additional
assumptions 1)
The utility
functions are homogeneous. That is Ui = Ui(X,Y) is
homogeneous of degree k if tk*Ui = Ui(t*X,t*Y) for all t > 0. This must hold for all
consumers i Î
(1,...,N). 2)
The utility
functions are identical or the distribution of income is fixed. The perfect market economy model |
|||
|
|
