Micro 3: Applied Welfare Flashcards
What is compensating variation?
Compensating variation is the addition to income required at new prices required to maintain old utility.
What is equivalent variation?
Equivalent variation is the required addition to income at old prices to reach new utility.
What is the Slutsky equation?
The change in demand caused by a price change equals a substitution effect (the change in the Hicksian demand - which holds utility constant), plus an income effect.
Why, if there are no income effects, does CV = EV?
Without income effects, all indifference curves are parallel. Therefore, the same amount of money is always required to move from new utility to old utility, regardless of prices, so CV = EV.
In order to maximise tax revenue, why are the best goods to tax those which are the most demand inelastic?
DWL falls if demand becomes less elastic. The Ramsey rule demonstrates that when we raise government revenue G whilst minimising deadweight loss G, we should tax goods with low demand elasticities.
How can we carry out cost-benefit analysis of costs and benefits that are not marketed?
- Subjective surveys
- Travel cost methods - indirect inference
- Regional intangible interventions - property prices?
What is an externality? Give examples.
When the action of one agent directly affects the utility of production possibilities of another agent, but not through the price mechanism, an externality is present. Externalities can be positive, such as innovation, or negative, such as pollution.
What is a pure public good? What is a club good, or a commons good, by contrast?
The key conditions are non-excludability (we cannot stop others from using the good: eg street lighting) and non-rivality (the good does not get depleted). Club goods are excludable, but non-rival (such as software). Commons goods are rival, but non-excludable (such as fish or the atmosphere). Pure public goods are both non-rival and non-excludable (such as national defence, or open-access research).
Why, under rational optimisation, will common property resources be overexploited?
Agents will enter until profits are zero. However, the socially efficient outcome involves maximising profits.
How can the ‘tragedy of the commons’ be avoided?
- Tax entry of boats until L* is also privately optimal
- Give ownership to a single firm
- Sell quotas equal to F(L)/L.
- Divide the good and give each agent exclusive rights to each part.
What is the Samuelson rule?
The Samuelson rule states that the optimal allocation of a public good is where the sum of the marginal benefits equals the marginal cost.
What is Lindahl pricing? How does it work?
Under Lindahl prices, each consumer is charged according to their marginal utility at x*. Then, when they optimise, they will choose the optimum amount such that together the public good can exactly be funded.
What is a Clarke-Groves mechanism?
A Clarke-Groves mechanism is a mechanism to make truth-telling a dominant strategy, so that the allocation method is strategy-proof and efficient.
What does the Coase Theorem state? Under what conditions does it hold?
Irrespective of the allocation of property rights, frictionless bargaining produces an efficient outcome in the presence of externalities.
This requires no transaction costs, and that there is one party on each side; if one side affected is a pure public good, this will not work.
What is cap-and-trade? How does it work?
Fix a quantity y. Tradable emissions permits are bought and sold. If this market is competitive, permits will be bought until permit price = marginal external cost at y and the externality is internalised.
