Reading Guide Lines

JR Chapter 5

March 29, 2022

Read these notes while studying Chapter 5 in JR. The notes also contain the additional
exercises (AA JR) mentioned in the block schedule. Pay attention in particular to cross
references to other chapters. The first number in each note refers to the page, the second
to the line/position.

1 Equilibrium in Exchange [5.1]

(196,23) Boldface letters denote vectors.

(197) The curves in the Edgeworth box are indifference curves of the consumers’ preferences
or, in case these preferences are represented by utility functions, level curves of these
functions. See JR, Section 1.2, pp. 5–18, for a basic exposition on preferences and
utility functions.

(198,26) The concept of Pareto efficiency (often also called Pareto optimality) was first intro-
duced in Chapter 4 of JR and will in the context of the present chapter be again
defined in Definition 5.1. A general definition is: An outcome in a multiple agent
situation is Pareto efficient if at any other outcome where some agent is better off
there is always some other agent that is worse off.
AA JR 1 Convince yourself that this is equivalent to Definition 5.1 (in the present
context of an exchange economy).

(198,-2) Again, Section 1.2 in JR gives an exposition on preference relations. Here, it is suffi-
cient to have a rough understanding of the meaning of i because most of the chapter
works with utility functions. Thus, if xi and yi are two bundles of goods for agent
i, then xi i yi means that agent i prefers xi to yi or is indifferent between them.
If the utility function ui represents this preference relation, then this is equivalent to
ui (xi ) ≥ ui (yi ).

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(199,9) Note that the summation in formula (5.1) is a summation of vectors in the usual
sense, namely coordinatewise.

(200) In the literature, a feasible allocation x ∈ F (e) that is not blocked by any singleton
coalition is usually called individually rational.
AA JR 2 Note (check by using Definition 5.2!!) that this is equivalent to xi i ei
for every i ∈ I. Hence, if there are only two agents, the core is exactly the set of all
feasible allocations that are Pareto efficient and individually rational: Why?

(201) To avoid confusion, we note that the word ‘equilibrium’ in Section 5.1 is used in a
more or less informal sense as a ‘barter equilibrium’. The ‘conclusion’ of this section
is that such barter equilibria should be core allocations and vice versa. Usually, the
word ‘equilibrium’ refers to ‘Walrasian equilibrium’, to be defined and studied later
on.

2 Equilibrium in Competitive Market Systems [5.2]

(203,8) The definitions of continuity, strong increasingness, and strict quasiconcavity can be
found in Chapter A1. For strong increasingness, see also Footnote 2 on this page.
Strict quasiconcavity means, geometrically, that if we take any bundle on a given
level curve of the utility function, and any other bundle on that level curve or on
a level curve corresponding to a higher utility, then any bundle on the line segment
strictly between these two bundles must lie strictly above this level curve.

(203,-8) p  0 means that every coordinate of p is positive. In general, x  y means that

xj > yj for every coordinate j. The ‘dot’ notation denotes the inner product, e.g.,
p · xi = nj=1 pj xij . Formula (5.2) is the so-called consumer problem. In general, it
P

can be solved by Lagrange or Kuhn-Tucker methods (see Section A2.3). A solution

will depend on the ‘parameters’ of the problem, namely prices p and income p · ei .
Thus, such a solution can be denoted xi (p, p · ei ). This is the so-called Marshallian
demand function. For a basic exposition on the consumer problem, see Section 1.3,
pp. 19–27.

(203) The budget set is a bounded and closed set. The first condition means (in this
case) that for every good there is a maximal and minimal possible amount, and the
second condition (in this case) that the boundary bundles (the bundles where goods
reach there maximal and minimal amounts) belong to the budget set. Specifically, the
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budget set is a line segment in IR+ if there are two goods, a triangle in IR+ if there are
m
three goods, etc. In general, a bounded and closed set in IR is called compact. See

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 Section A1.3 for details. Existence of a utility maximizing bundle of goods (referred
to here) follows from the Theorem of Weierstrass (Theorem A1.10), which says that
a continuous function on a compact set has a maximum and a minimum. Uniqueness
of this solution follows from strict quasiconcavity of ui , as claimed in the text. The
proof of this claim is as follows. Suppose xi and x0 i are both solutions of (5.2), and
suppose they are not equal. Then ui (xi ) = ui (x0 i ) (why?). Let x00 i be the average
bundle, x00 i = (1/2)xi + (1/2)x0 i . Then x00 i is in the budget set (why?) and by strict
quasiconcavity of ui , we have ui (x00 i ) > ui (xi ). This contradicts xi being a solution
of (5.2), and therefore completes the proof.

(203,-6) This theorem tells us that (under certain conditions that are satisfied here) the so-
lution of a maximization problem like (5.2) varies continuously with the parameters
of the problem, in this case the vector of prices p  0.

(204,-6) “Continuity follows from Theorem 5.1”: moreover, from the fact that sums (or dif-
ferences) of continuous functions are again continuous, and also constant functions
(i.c., eik ) are continuous.

(204,-5) AA JR 3 Write down the proof of the fact that individual demand functions are
homogeneous in prices.

(204,-2) AA JR 4 Write down a proof of the fact that, when ui is strongly increasing, at
the solution of (5.2) the budget constraint holds with equality. Check the rest of the
proof of Walras’ Law carefully.

(207) Before studying the proof of Theorem 5.3 first consider the formulation of the Brouwer
Fixed-Point Theorem (Theorem A1.11) and (at least) its geometrical interpretation.
Further, be aware that Theorem 5.3 holds for a function z(p) with the three properties
stated. Of course, we have an aggregate excess demand function (as in Definition 5.4)
in mind (and it will turn out that the three properties are satisfied for this function),
but the theorem is more general.

(208) AA JR 5 Convince yourself of the truth of the inequality in (P.1): Write down its
derivation.

(208,-8) AA JR 6 Convince yourself of the claims in this and the following lines. Again,
write down!

(209) AA JR 7 Convince yourself of the truth of (P.2) by writing it out in detail.

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 (209) The term in brackets in the left-hand side of (P.2) is bounded below by zero (why?)
and bounded above by n+ nm=1 1 = 2n (why?). So the whole left-hand side converges
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to zero as pεk converges to zero.

(209) The proof of Theorem 5.4 is elementary but requires a good understanding of conti-
nuity of functions in terms of sequences. Section A1, in particular pp. 430–431, may
be of help.

(211) See pp. 24–26 on CES utility functions. Repeat the calculation of the corresponding
Marshallian demand functions. Verify all calculations in Example 5.1.

(214,19) The distinction made in this book between strictly and strongly increasing functions
is explained in Definition A1.17.
AA JR 8 Argue that a strongly increasing function is also strictly increasing. Give
an example of a strictly increasing function that is not strongly increasing.

(219) AA JR 9 Write down the argument in the last paragraph of the proof of Theorem
5.8.

3 Equilibrium in Production [5.3]

(280) It does not harm to glance through Chapter 3 or at least the first few pages of Section
3.2 before embarking on Section 5.3. The least you should do is to make a picture
(for instance for the case of two goods, n = 2) of a set as in Assumption 5.2.
AA JR 10 Draw the production possibility set corresponding to the production
√
function y = f (x) = x. Which of the properties 1–4 in Assumption 5.2 are satisfied?
How can we adapt the set (or the function) such that all these properties are satisfied?
Calculate the profit function Π(p) and also the supply function y(p).

(221) See the Theorem of the Maximum, applied here to problem (5.3) resulting in the
supply function and the profit function.

(221,-3) AA JR 11 Verify the claims in lines 5–7 on homogeneity of the profit and supply
functions.

(224,-11) By Theorem 5.9, mi (p) is continuous because the profit function is continuous.
Hence, by the remarks on the bottom of page 26 in Chapter 1, xi (p, y) is continuous
in (p, y) ∈ Rn++ ×Rn+ .

(229,10) These demand functions (of a consumer with Cobb-Douglas utility) were derived in
Exercise 1.20.
AA JR 12 Do this exercise!

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 4 Core and Equilibria [5.5]
(241,-12) By Theorem 5.5 a WEA exists, and by Theorem 5.6 it is in the core.

(242) Exercise 5.16 asks you to give a general proof of Theorem 5.16.

(245,9) Consistently with the rest of the book, read ⊃ and ⊂ instead of ⊇ and ⊆.

(245) AA JR 13 Write down the proof of Lemma 5.3 in a more formal way.

(247,9) By Theorem 5.6...instead of 5.5.

(248,3) M RS denotes the marginal rate of substitution, i.e., the slope of the line tangent to
an indifference curve. See page 18.

(250,1) Convince yourself of this, at least, by making a picture.

(250) AA JR 14 Derive (P.2).

(251,2) Basically, this follows from Pareto optimality (cf. Exercise 5.27).