Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 29

In Chapter 9 we showed how a shift in demand could be analyzed using a model of a single market. How would you illustrate an increase in the demand for good X in the general equilibrium model pictured in Figure? Why would such a shift in preferences cause the relative price of X to rise? What would happen to the market for good Y in this case? Should your discusssion here be thought of as ''short-run'' or ''long-run'' analysis?
With an arbitrary initial price ratio, firms will produce X1, Y1; the economy's budget constraint will be given by line CC. With this budget constraint, individuals demand X01 , Y1, that is, there is an excess demand for good X (X01_ X1) and an excess supply of good Y (Y1 _ Y01 ). The workings of the market will move these prices toward their equilibrium levels P_X ,P_Y. At those prices, society's budget constraint will be given by the line C*C*, and supply and demand will be in equilibrium. The combination X*, Y* of goods will be chosen, and this allocation is efficient.