Consider an exchange economy with two consumers, Shoji and Tola, who trade only two goods: cakes and T-shirts. Quantities of cakes are measured vertically, and quantities of T-shirts are measured horizontally. Shoji’s origin should be placed at the bottom left.

A. Draw an Edgeworth box diagram in which the two consumers can exchange the two goods.

a.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 Shoji and Tola.

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.

B. Using a new box diagram for Shoji and Tola, mark a possible initial endowment point and, with the help of a budget constraint line and indifference curves, show an excess demand for T-shirts at a given price and explain the economic significance of excess demand. Label your diagram in full.

C.Reproduce the diagram you used for Q2 and explain what must happen to the price of T-shirts relative to the price of cakes for equilibrium to be established, eliminating the excess demand for T-shirts. Show this on your diagram and explain the adjustment process and equilibrium outcome in full.

D.Discuss in full the implications for efficiency and fairness of the First Welfare Theorem and the Second Welfare Theorem.

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The detailed answer for the above question is provided below A Heres a description of the Edgeworth box diagram for the exchange economy involving Shoji and Tola The horizontal axis represents the qua... View the full answer