5_Welfare Economics

Question 1

Pareto criterion

Answer 1

Given an initial allocation of goods among a set of individuals, a change to a different allocation which makes at least one individual better-off without making any other individual worse-off is called a pareto improvement

Question 2

Pareto efficiency:

Answer 2

An allocation is defined as “pareto efficient” or “pareto optimal” when no pareto improvements can be made. This is what economists usually mean by efficiency

Answer 3

W = U_A + U_B

• The utility of both individuals counts the same, no matter how rich they are
• Giving one additional € to a rich person has the same value to society as giving it to a poor person
• Social Indifference Curve (SIC): set of welfare allocations, for which society is indifferent

SWF in general form: W = W (U_A, U_B)

Question 4

First fundamental theorem of welfare economics

Answer 4

The equilibrium solution in a market under perfect competition (no externalities, full information etc.) is pareto efficient

→ Net benefits are maximized and cannot be improved through government intervention

Question 5

Pareto efficiency:

Answer 5

If no allocation is possible that will make at least one person better off without making another person worse off

Question 6

Efficieny

Answer 6

• a (market) demand curve shows the marginal (maximum) willingness-to-pay of all potential buyers
• for a rational agent this is equal to the monetary value of the satisfaction derived from that good
• the supply curve is identical with the marginal cost curve
• efficient solution (maximum net benefit) is given by MB =MC