ACCPT4

Question 1

What is the First Fundamental Theory of Welfare Economics (FFTWE)?

Answer 1

If all agents are price takers and markets exist for all commodities then market trading will result in a Pareto efficient outcome.

Question 2

What is the Second Theory of Welfare Economics (SFTWE)?

Answer 2

If all ICs and isoquants are convex, then for each Pareto efficient allocation, there is an initial resource endowment such that price mechanisms will lead to the P.E. outcome.

Question 3

What are the three Social Welfare Functions (SWF)?

Answer 3

1) Benthamite SWF - W=Ua+Ub… the two utilities are perfect substitutes for each other.
2) Rawsian SWF - W=min{Ua,Ub}… the two utilities are perfect complements.
3) Bergson SWF - Convexity (averages are preferred to extremes)

Question 4

What are the axioms for Arrow’s Impossibility Theorem?

Answer 4

1) Completeness - social ranking can order all outcomes.
2) Transitivity - rankings are consistent.
3) Pareto - If all people prefer A>B, then the social ranking is A>B.
4) Non-dictatorial - No single person’s preferences can determine social ranking.
5) Pairwise independence - A ranking of two outcomes should not be dependent on a third outcome.

Question 5

Explain the impact of majority voting on AIT?

Answer 5

-AIT 3 and 4 are satisfied.
-People may have different rankings, therefore, not transitive.
-A third political party makes it not Pairwise independent.

Question 6

What is Kaldor/strong and weak compensation?

Answer 6

-Strong - The losses to B can be fully compensated, whilst also allowing individual A to benefit.
-Weak - Welfare improvement but can also work the other way.