General Equilibrium and Welfare Economics

Question 1

Partial Equilibrium

Answer 1

Looks at one market at a time in isolation

Question 2

General Equilbrium

Answer 2

Looks at all markets together, and how they are interconnected. Everything is endogenous

Question 3

Market clearing

Answer 3

demand=supply

Question 4

Solving a simple general equilibrium model

Answer 4

1. Define the allocation
2. Feasible allocation to be pareto optimal iff there is does not exist another feasible allocation
3. Form the social planner problem (max utility s.t. the constraints)
4. Form the Lagrangian
5. Derive the first order conditions.

Question 5

Marginal Product of Labour

Answer 5

δG/δL

Question 6

Marginal Product of Capital

Answer 6

δH/δK

Question 7

Marginal Technical Rate of Substitution

Answer 7

δG/La / δG/δKa

Slope of isoquant of production

Question 8

Production Efficiency

Answer 8

MTRSa=MTRSb

Question 9

Marginal Utility of A1 for person 1

Answer 9

δU1/δA1

Question 10

Marginal Utility of A2 for person 2

Answer 10

δU2/δA2

Question 11

Marginal Utility of B1 for person 1

Answer 11

δU1/δB1

Question 12

Marginal Utility of B2 for person 2

Answer 12

δU2/δB2

Question 13

Marginal rate of Substitution for person 1

Answer 13

Marginal Utility of A1/Marginal Utility of B1

Question 14

Consumption efficiency

Answer 14

MRS1=MRS2

Question 15

Overal efficiency

Answer 15

Brings together the production side and consumer side.

MRS = MRT

Question 16

Marginal rate of transformation

Answer 16

Slope of the PPF curve

δH/δLb /δG/La = δH/δKb / δG/δKa

Question 17

Working through a general competitive equilibrium

Answer 17

Worked out as a vector of prices and utility. Also have the market clearing functions.

1. work out the first order conditions wrt to the consumers. my maximising their utility and forming a lagrangian
2. The do the same for the producers by maximising their profit function and finding the first order conditions.
3. Work through to see if they satisfy consumption, production and overall efficiency

Question 18

First theorem of welfare economics

Answer 18

A general competitive equilibrium allocation is Pareto Optimal. i.e. all three of the criteria (overall, production and consumption) are satisfied.

Question 19

Second Theorem of Welfare economics

Answer 19

Any pareto optimal allocation can be obtained via a general competitive equilibrium provided the government is able to implement the required system of lump sum (non distortionary) taxes and transfers.

Question 20

Failure of welfare theorems lies in…

Answer 20

Distortionary taxation

Question 21

Example of distortionary taxation

Answer 21

where the government places a tax on labour income of t in sector A so firm A has to pay (1+t)pL for labour whilst consumers/workers receive only pL. Tax revenue of tpL goes to the government. This then affects the production efficiency of the market.

Question 22

Another example where the welfare economics fails…

Answer 22

Externalities

Question 23

Negative consumption externality

Answer 23

When consumption of some goods by some consumers adversely affects the welfare of other consumers. eg smoking or loud music

Question 24

What effect does an negative consumption externality have

Answer 24

It changes the first order conditions

Question 25

Overall efficiency with externality

Answer 25

MRS1>MRS2=MRT

when negative externality A1 hurts person 2

Question 26

Another failure of welfare economics

Answer 26

public goods

Question 27

What is a public good?

Answer 27

A good x is said to be a public good if consumption of x by one person does not preclude consumption of x by another person, and no one can be excluded from consuming x

non rival and non exclusive

Question 28

How does the fact that good A may be a public good affect the set up of the constrained optimisation problem?

Answer 28

As total supply of A is the same as A1 or A2 there is no need to split the consumption as such A=A1=A2. This then means we have less FOCs

Question 29

What conditions are satisfied if there is a public good present?

Answer 29

Overall and production

Question 30

Stopler-Samuelson Theorem

Answer 30

An increase in pa/pb increases the real wage rate and decreases the real rental rate

Question 31

Rybeynski Theorem

Answer 31

1) An increase in K results in an increase in production of the capital intensive commodity B and a decrease in the production of the labour intensive commodity A.
2) An increase in L results in a decrease in the capital intensive commodity B and an increase in the labour intensive commodity A.

Question 32

Assumptions of the 2x2 model

Answer 32

1) G(.) and H(.) exhibit constant returns to scale

2) Sector B is capital intensive and Sector A is labour intensive