LECTURE 1 Flashcards
1st welfare theorem
The allocation of commodities in a competitive equilibrium = Pareto efficient.
4 conditions for 1st welfare theorem to hold
- No externalities.
- Perfect competition - price takers.
- Perfect information.
- Rational agents.
Pareto efficient =
impossible to find a technologically feasible allocation the makes someone better off without making some one else worse off.
What kind of requirement is PE? Why is it not necessarily equitable?
Desirable, but weak - one person consuming everything is PE.
2nd welfare theorem
any PE allocation can be made a market equilibrium.
V. important condition for 2nd welfare theorem to hold. What does it mean?
CONVEX preferences = concave ICs = averages > extremes - one of axioms of well-behaved ICs.
How can any PE allocation be made a market equilibrium?
BY redistributing initial endowments - individualised lump sum taxes based on individual characteristics, not behaviour. Then let market work freely.
Why does 2nd welfare theorem not work in reality?
Government cannot observed individual characteristics and so cannot use lump sum taxes. End up using distortionary taxes on economic behaviour.
Illustration of 2nd welfare theorem problem with disabled vs able population.
In free market outcome, disabled have no earnings and able earn say $100. 2nd welfare theorem = government can tell them apart even if able do not work so can lump sum tax for able at $50 and give to disabled. Able have an incentive to keep working as still taxed regardless. In reality, gov can only tax those who work = disincentive to work.
state 4 market failures
- externalities.
- imperfect competition
- imperfect / asymmetric information
- Individual irrationality.
4 types go government intervention
- taxes and subsidies
- quantity regulation
- public provision
- public financing.
How do public provision and public financing differ>
Provision = gov directly provides it. Financing = gov pays for it, but private sector provides it.
Direct effects of government intervention capture…
The effects of the intervention if individuals did not change their behaviour. Relatively easy to compute.
Indirect effects of government intervention capture…
The effects of intervention that arise because individuals change their behaviour in response = unintended effects.
3 reasons government provision may not be desirable…
- Information problems: what Q if gov cannot capture all preferences.
- DWL due to myopia and max own utility.
- Incentive effects.
Political economy
the theory of how political process produces decisions that affect the economy.
Public choice =
a sub-field of political economy from a Libertarian perspective that focuses on gov failures.
NORMATIVE public economics =
how things SHOULD be: subjective and theoretical.
POSITIVE public economies =
analysis of how things rly are: objective, empirical.
Paternalism/Libertarian view of gov =
Individual failures don’t exist and gov tries to impose its own preferences against individuals will.
Behavioural economic view of gov
Individual failures exist = need intervention
Decentralised states =
larger % of taxes and spending that place at the local level.
What is voting with your feet and how does it come about
When states are decentralised individuals can move and this creates competition between local governments.
Why is redistribution harder to achieve at local level;?
Since rich can just leave state if taxes too high - bit can’t leave country.
2 types of spending + egs.
Public goods.
Social spending e.g. education, insurance, pensions.
How does CS depend on PED?
More elastic = less CS
Inelastic = more CS
How does PS depend on PES?
Inelastic = more PS
CS + PS is maximised when…
D=S at competitive equlibrium
DWL =
The reduction in social efficiency from denying trades fo which benefits > costs when quantity differs from socially efficient quantity.
The DWL triangle always points to…
social optimum
What does a social welfare function do?
Combine utility functions of all individuals into an overall social utility fucntion.
Utilitarian / Benthamian SWF
maximise sum of all utilities.
U1 + … + Un
Rawlsian SWF
maximise utility of least well off member.
Min(U1 –> Un)
How do utilitarian and Rawlsian compare on redistribution implications?
Utilitarian: MU of income declines with incomes transfers from rich to poor increase total utility.
Rawlsian = even more redistribution - extract as much tax from rich as possible.
Utilitarian cares about … income & implications on consumption lovers.
NET income
people who enjoy consumption more should get more income.
Empirically: do people think consumption loving matters?
NO - contracts with utilitarian
Empirically: do people think hard working more deserving?
either more deserving or equally deserving conditional on total earnings.
Empirically: do people think ability to work matters?
Yes - most deserving are those who are disabled / unemployed but looking for work.
conclusion on empirical results relating to redistribution
People favour redistribution if they feel inequality are unfair i.e. individuals have no control.
but unfair means different tings to different people.
Utilitarian vs libertarian views on whether disposable income or taxes matter.
Utilitarian = only disposable income matters Libertarian = only taxes paid matters.
Empirically, do we see support for utilitarian or libertarian view?
taxes paid positively affects deservedness = libertarian
But disposable income -VE affects deservedness = utilitarian - both matter for social preferences.
