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I am attempting to solve a general equilibrium problem from the textbook Jehle and Reny. However, I am slightly confused if my approach is correct. The question is as follows.

Consider an exchange economy with one good and two time periods. Two consumers have the following utility functions:

$U_A (x_{A1}, x_{A2}) = \sqrt{x_{A1}} + \sqrt{x_{A2}}$

$U_B (x_{B1}, x_{B2}) = \sqrt{x_{B1}} + \sqrt{x_{B2}}$

where $A1$ corresponds to time period 1 and $A2$ corresponds to time period 2.

Each consumer is endowed with one unit of the good at time period 1, BUT only B is endowed with 1 at time period 2 (A is endowed 0 at time period 2). Note that storage of the good is not possible, but consumers can engage in trade in period 1. Calculate the competitive equilibrium allocations.

I am not sure if I am overthinking the problem, but since the good is perishable. Will both agents just consume their endowments (e.g., agent 1 consumes 1 in the first period, and agent 2 consumes one in the first and one in the second).

Is there a scenario where agent 1 would want to sell some of his endowment in period 1 to purchase some in period two? Given his utility function I believe this would be the case, but showing it seems much different than the typical GE problems I have been solving.

Thanks

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Of course, note that in general, consumer B is willing to increase her consumption in period 1. it is a matter of simply solving the problem in the regular way. i.e, MRS=p and find the $p$ which "clears" the market.

Normalize the price of the current period good to $1$ and let $p$ be the price of the second period good, then the optimum for player $A$ is: $\max_{x_{A1},x_{A2}} \sqrt{x_{A1}}+\sqrt{x_{A2}}$ s.t $x_{A1}+px_{A2}\le 1$ Clearly the constraint is binding and thus the problem becomes: $\max_{x_{A1}} \sqrt{x_{A1}}+\sqrt{\frac{1-x_{A1}}{p}}$ Calculate the first order condition, repeat the process for consumer B etc...

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  • $\begingroup$ I didn't think this would work out since I couldn't see how the restriction of non-perishable goods was imposed. But worked out! Thanks! $\endgroup$ – jbrau May 14 '17 at 3:29

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