[6] General Equalibrium and Welfe Flashcards
WALRASIAN AUCTIONEER
We assume that an auctioneer is employed to set a ____for good 2 __ ___ ___good 1.
The individuals A and B are __ -__, and do not attempt to deceive the auctioneer about their ____.
[Alternatively, A and B represent large cohorts of two different types of consumer]
Only when the auctioneer finds a __-__ price does trading proceed. We call this ___.
We assume that an auctioneer is employed to set a price for good 2 in terms of good 1.
The individuals A and B are price-takers, and do not attempt to deceive the auctioneer about their preferences.
[Alternatively, A and B represent large cohorts of two different types of consumer]
Only when the auctioneer finds a market-clearing price does trading proceed. We call this Tatonnement.
What must the budget line always pass through?
The endowment point
What is Walras’ Law?
Walras’s law is a principle in general equilibrium theory asserting that budget constraints imply that the values of excess demand must sum to zero regardless of whether the prices are general equilibrium prices
IF SUBSTITUTION EFFECTS OUTWEIGH INCOME EFFECTS can we find a market clearing price?
IF SUBSTITUTION EFFECTS OUTWEIGH INCOME EFFECTS
then a lower price for G1 would imply both parties want more of G1 and less of G2 than in equilibrium at D. The market doesn’t clear.
IF INCOME EFFECTS OUTWEIGH SUBSTITUTION EFFECTS What could happen to each parties demand for Good 1?
In this case, what is possible?
it is conceivable that a fall in the price of G1 may cause one consumer to demand more of it and the other to demand less.
In this case, MULTIPLE EQUILIBRIA are possible even with a single endowment point.
Every point on the contract curve represents a possible ___ ___, where A’s indifference curve and B’s indifference curve are ___, but also every point on the curve is __ ___
competitive outcome
tangent
pareto efficient
What is the First Fundamental Theorem of Welfare Economics?
“As long as producers and consumers act as price takers and there is a market for every commodity, the equilibrium allocation of resources is Pareto efficient. That is, the economy operates at some point on the utility possibilities frontier”.
All agents are price takers \+ There is a complete set of markets = Pareto Efficiency
If A or B have monopoly power, they may be able to influence the auctioneer’s ___ by altering their bids.
In this case, the outcome would be __ ___
price
Pareto inefficient.
What does UPF Stand for and represent?
Utilities possiblities frontier
Combination of A and B Utilities that its possible to reach without making other worse off. On the edge, is pareto efficient and each different point represents a trade off.
Second Fundamental Theorem of Welfare Economics?
How can you maximise social welfare?
“Provided that all indifference curves and isoquants are convex to the origin, for each Pareto efficient allocation of resources there is a set of prices that can attain that allocation as a general competitive equilibrium.”
Diminishing marginal returns to substitution
+ the ‘correct’ initial distribution
= You can maximise social welfare
Logic behind this: every Pareto efficient point lies on the __ __. And every point on the contract curve is the ___ from one initial starting distribution of resources.
So if you can ___ wealth costlessly, then you can use the __ to achieve the best possible overall use of resources.
In reality, there is a trade-off between __ and __
contract curve
equilibrium
redistribute
market
efficiency, equality
What does it mean to appraise an investment project?
Initial and future what?
An investment project (private or public), generally involves spending money up front (capital investment), to provide the capacity to earn an income (or provide a benefit) later on.
Negative initial cash flow (investment)
Positive future cash flows (returns, which are discounted)
How do we decide if an investment project is attractive?
Sum of the discounted cash flows to find NPV and if positive, investment is worth it.
If low interest rates in the economy, more investment appraisals seem attractive
If you are a private firm, Cash flows/revenue should be net of ___.
taxes
Capital may need an annual maintenance. This is a __ ___, and should be included in the DCF analysis.
Capital may need replacing or upgrading every few years, or decommissioning at the end of the investment. These costs ___be included.
Accountants cover these costs in ___ statements as a ‘___’ charge. We don’t put an extra ‘____’ cost into the DCF, as, again, it would be double-counting.
cash flow
should
Income
depreciation, depreciation
When you do a DCF analysis of a project, it is the __ ___ that you discount, not the ___ statement.
But if the accountants do the P/L analysis correctly, it should give __ ___ __
Often, the project appraisers will work out both a DCF and a financial projection (P/L account) for the project – both should be consistent.
Cash flow,
income
the same answer.
What is the main difference between incomce statement and DCF?
Income = looking at past records
DCF = making future predictions
What examples can make the outcome of these forecasts uncertain? 4
Economic growth
Key prices
Exchange rates
Technology
What does subjective probability entail?
What does the sum of subjective probabilty always =?
What can it be used to calculate?
Attaching a calculated probability to a potential outcome.
1
Can be used to calculate a weight-average net present value.
NPVe= NPV1 x P1 +NPV2 x P2 +NPV3 x P3…
What is the difference with public sector appraisals?
How are they modified?
The public sector will do modified DCF appraisals, to examine things like:
Returns on public sector investments (public goods, roads, schools, hospitals)
The case for subsidies for specific private projects.
The public appraisals will be modified, to take account of social factors.
What is on the axis of welfare analysis for a new road/bridge/railway?
X axis = added capacity
Y axis = cost or price of project
Taxation. If the project is profitable, it will yield ___ ____. This is a public benefit.
tax revenue
External benefits Examples:
x3
Regional gains. Maybe jobs gain.
Spillovers to other firms (for example, from research subsidies).
Environmental benefits. eg: reducing carbon emmissions with electric cars, congestion from alternative routes, sugar consumption down etc
What factors may influence the decisions of public investments ? [1]
(Think of who makes the decisions)
What two problems need to be considered with Gov Intervention?
Pork barrelling: instances in which ruling parties channel public money to particular constituencies based on political considerations, at the expense of broader public interests
Tragedy of the commons
Free-rider problem
Negative Externalities x4 egs
Definition.
Noise
Pollution
Bad smells
Congestion
These are costs borne by people other than the company/body doing the investment.
What can individuals and governments do to protect themselves against negative externalities?
individuals, groups or other companies can force a company to take account of externalities (by threatening to sue). This really depends on the legal costs of the case. Can protest/campaign for change
Where a pollutant is widespread, the government may seek to impose a pollution tax. This means that private firms will take account of the marginal cost of the pollutant in their own appraisals (rather than requiring specific regulation/subsidies) [difficult to calc tax]
Depends on free-riders
What is Current UK best practice for appraising projects?
The ‘Green Book’
Also, take advice from consultants etc
