Lecture 5 General equilibrium

Question 1

Pareto optimal

Answer 1

If no one can be made better off without making someone else worse off

Question 2

Pareto improvement

Answer 2

A change which makes some people better off without making someone else worse off.

Question 3

First theorem of welfare economics

Answer 3

All competitive market equilibria are Pareto efficient
- The idea is that competitive trading and production leads to pareto efficient outcomes
- Guarantees markets exhaust gains to trade.
- Silent about distribution of economic benefits
- Theorem requires perfect competitive markets

Question 4

Second fundamental theorem of welfare econ

Answer 4

Any pareto efficient outcome can be achieved through trading in a competitive market if endowments are first redistributed among agents.

Question 5

Whats the additional condition which holds with stwe?

Answer 5

• Consumer preferences must be convex
• Convex if the set of preffered allocations are convex

Question 6

Covex set

Answer 6

A set is convex if the line segment joining any two points that belong to the set also belongs to the set

Question 7

What does economic efficiency require?

Answer 7

1) Exchange efficiency
2) Production efficiency
3) Product mix efficiency

Question 8

Exchange efficiency

Answer 8

Given what the economy produces, goods and services are distributed in a pareto-optimal way.

Question 9

Production efficiency

Answer 9

Given an economy’s resources it is not possible to increase the production of one good without decreasing another

Question 10

Product mix efficiency

Answer 10

The goods produced must be ones desired by individuals

Question 11

Simplest exchange economy

Answer 11

• Quantity of given goods is known
• Economic problem is to allocate the goods among consumer

Question 12

Notion of equilibrium

Answer 12

• Consists of :
• Set of equilibrium prices
• Consumotion bundle for each consumer

Question 13

Endowment allocation

Answer 13

One feasible allocation is the before trade allocation of endowments

Question 14

What does pareto optimality require?

Answer 14

It requires the marginal rate of substitution to be identical across all consumers

Question 15

What is the contract curve?

Answer 15

it is the set of all pareto-optimal allocations.

Question 16

Walras’s law

Answer 16

Its an identity, ie statement that is true for only positive prices (p1,p2) whether these are equilibrium prices or not

Question 17

Implications

Answer 17

An excess of demand in one market implies an excess demand in the other market