Thursday, February 27, 2014

Measuring Supply and Demand in a Simulated Economy

Isn't Equilibrium Where Supply Equals Demand?

I was on vacation last week (which is why I haven't posted in a while) and spent some time thinking about where I want to go with the blog. I realized that it would probably be best to focus on basic principles before trying to get too creative with things like variations on the bargaining model. Besides, we can get a lot more mileage out of these key ideas.

So, what's all this talk about competitive equilibrium being the allocation where agents' marginal rates of substitution are equal to each other and their utility curves are tangent? Isn't it a lot easier to just say that equilibrium is where supply equals demand? Well, yes, it is, and actually, that is how we found the competitive equilibrium; we just approached it from another perspective. Recall that we did calculate the agents' demand curves along the way. As we'll see below, we actually found the supply curves as well, even if that isn't obvious right now.

Wednesday, February 12, 2014

Bargaining Power in a Simulated Barter Economy

What about non-competitive equilibria?

In my last post, I went through the process used to derive the competitive equilibrium allocation that I plugged into the trade function in our economic simulator. It wasn't just some arbitrary trade rule; I derived it from the agents' utility functions, making sure to meet certain conditions to define a competitive equilibrium. 

To reach a competitive equilibrium, we must assume that both agents are price takers. That is, they don't set the terms of their trade; the market does, and they just trade according to the market price. In a competitive market, the equilibrium price is the one that satisfies the demand functions of all the agents, even when there are only two of them.

But what if we relax those assumptions? Our model is still using a barter economy, after all, and some people are better negotiators than others. So let's consider trades where the outcome will still be on the contract curve (i.e., the outcome will still be an equilibrium; i.e., there will be no more ways to trade without making someone worse off). But now let's look at what happens when one agent is able to negotiate a better price. The weaker negotiator will still benefit from trade, but not as much as they did in a competitive equilibrium.

Monday, February 3, 2014

Why We Trade: Some Fundamental Economic Principles

How to Slice a Pie

Welcome to economics boot camp.  There are a few key ideas that I'd like to take time to explain, because they're absolutely crucial to building up the models I'll be writing about here. Even more important than the math, though, is getting the intuition behind these concepts. If you understand the rest of this post, you should have a solid grasp on how I am building the models for my simulation, and why they work the way they do.