General Flashcards
First law states that any competitive equilibrium is Pareto efficient. It says market is best allocator I.e. lassiez faire is best form of economy as Pareto efficiency is automatically achieved via competitive equilibrium. Second law states that any Pareto efficient allocation is achievable as a competitive equilibrium via redistribution, for a particular price vector. It talks of how any Pareto efficient allocation is achievable through the market via redistribution of wealth.
What does first law of welfare economy basically say?
any competitive equilibrium is Pareto efficient. thus market automatically achieves Pareto efficiency via market equilibrium. Lassiez faire is the best form of economy. It glorifies the invisible hand of market theory
What does the second law of welfare economics state?
Any Pareto efficient allocation can be achieved as a market equilibrium, for a particular price vector via redistribution of wealth. Redistribution can achieve any Pareto efficient allocation as a competitive equilibrium. This downplays the invisible hand of market as it emphasises on redistribution by a governing bodu
A situation in which the lender cannot observe inherent characteristics of borrowers (e.g,, riskiness), which can lead to inefficiency and credit rationing is called
adverse selection
what is adverse selection?
It occurs from LACK of symmetric information. For eg, banks do not have info regarding ability to repay. Or insurance company don’t have info about the lifestyles of different people so they end up insuring and charging same premium to both Debbie (who smokes) and Somu (who doesn’t), although it is riskier to insure Debbie. This leads to adverse selection.
it creates problems regarding the occurrence of transactions. It is a market failure. It leads to inefficiency in price and quantity.
What is moral hazard?
It occurs due to asymmetrical information in the market. Or when people lie / change their behavior AFTER the deal is struck, in order to avoid (or because they don’t have pay for) the risks. It affects behavior/consequences after the deal is made.
moral hazard occurs when a party provides misleading information and changes his behavior when he does not have to face consequences of theriskhe takes. For example, assume a homeowner does not have home insurance orflood insuranceand lives in a flood zone. The homeowner is very careful and subscribes to a home security system that helps prevent burglaries. When there are storms, he prepares for floods by clearing the drains and moving furniture to prevent damage.
However, the homeowner is tired of always having to worry about potential burglaries and preparing for floods, so he buys home and flood insurance. After his house is insured, his behavior changes and he is less attentive, leaves his doors unlocked, unsubscribes to the home security system and does not prepare for floods. In this case, the insurance company is faced with the consequences and risks of floods and burglaries, and the problem ofmoral hazardarises.
Read more:What is the difference between moral hazard and adverse selection? | Investopediahttp://www.investopedia.com/ask/answers/042415/what-difference-between-moral-hazard-and-adverse-selection.asp#ixzz4fYK0JGS0
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Ways to neutralize externalities
- Merger/Internalisation
- pigouvian Taxes
- Costless transactions (Coase Theorem)
So Government doesn’t necessarily have to get involved
Coase Theorem
Costless transactions between the person/firm causing externality and the person/firm being affected by it can cause the SOCIALLY EFFICIENT level of the externality causing good to be produced
For public goods, what is the efficiency condition?
sigma MRS xg = sigma ( MU from public good/MU from private good) = MRT (with Pvt good on y axis ) = Price of pub good/price of Pvt good
also called Samuelson condition
What sort of a utility function has only income effect and 0 substitution effect?
U = min (x1, X2)
What utility function has only substitution effect and 0 income effect?
Quasilinear utility function.
U = f(x) + y
the price effect of x has only substitution effect, 0 income effect
Price ceiling for monopoly
If Govt sets a binding price ceiling for a monopoly, the new price for the Product will always be EQUAL to the price ceiling.
