The Edgeworth Box

and
Pareto Optimal

Presented By:
Sudhir Kale.
MITCON Institute of
management, Pune.
 The Edgeworth Box

 Francis Edgeworth developed the

method of analysis in the last
portion of the 19th century.
 Provides a powerful way of
graphically studying exchange and
the role of markets.
 Understanding the Edgeworth Box is
critical to understanding exchange
and markets.
 The modern version of diagram is
commanly referred to as
 How To Form an
Edgeworth Box

 Rotateone of the graphs onto the

other one until it forms a box.
 Consider two
consumers
and two products
y1 y2

y1 y1
0 0
x1 x1 x2
x1
 The Edgeworth Box

y1
0
x1

y1
0
x1
 The Edgeworth Box

y1
0
x1

y1
0
x1
 The Edgeworth Box

y1
0
x1

y1
0
x1
 The Edgeworth Box

y1
0
x1

x1
y1
0
 The Edgeworth Box

0 x1
y1
y1
0
x1
The Edgeworth Box

x1
0
y1

y1
0
x1
 Pareto Optimal

 When no change can make one

better off without making the other
worse off.
 With general equilibrium of
production & exchange, economic
efficiency is maximum & we have
Pareto Optimal.
 According to this concept, a
distribution of inputs among
commodities & of commdities
 The Edgeworth Box
x2
III1 II1 I1

y2

A is the
equilibrium point
where pareto
optimum occuring.

C 2
II 1
y1
I 2 I 12
II
x1
 The Edgeworth Box
x2
IV2 III2 II2 I2

B y2

E”
E’
Contract line
Which is locus of a
Pareto optimals.
A
E

C
y1

I1 II1 III1 IV1

x1
 Understanding the
Picture
 Any point in the Edgeworth box
indicates a particular distribution of
the two goods among the two
individuals, e.g. A and B.
 Each individual has an indifference
curve going through that point.
 If the distribution is Pareto optimal,
those two indifference curves are
tangent at that point.
 The Edgeworth Box
x2
III2 II2 I2

B y2

E”

E’

A
Price or budget
E line

C
y1

I1 II1 III1
x1
 Tangent line is really a
budget line for both
individuals
 Ifone extends the tangent line to
each axis, we now have a budget
line.
 For example, the budget line for 1st
individual is where I is the income
that person get from selling the X
and Y he/she holds at the Pareto
optimum point.
Income/pri
ce of y
Budget Line

C Price or budget
line
y

x Income/p
rice of
x
 Marginal Rate of
Substitution
Income /Py

Slope of indifference curve gives

the marginal rate of substitution

Price or budget
line
y

x Income /Px
 MARGINAL RATE OF
SUBSTITUTION

m arg inal utility of x

MRS xy =
M arg inal Utility of x
MRS =

m arg inal utility of y

 At point D

 Slope of indifference curve equals

the slope of the budget line or
 MRSxy = -Px/ Py
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