Theme 1

Question 1

What is Pareto Optimality?

Answer 1

Pareto optimality occurs when there is no way to allocate goods and services to make an individual better off without making someone else worse off. It applies to both consumer and production perspectives

Question 2

What is a Pareto Improvement?

Answer 2

A Pareto improvement is a change in the allocation of goods and services/resources that benefits at least one entity without making another entity worse off. If Pareto improvement is possible, Pareto optimality has not been reached.

Question 3

What is the Kaldor-Hicks Compensation Principle?

Answer 3

The Kaldor-Hicks principle suggests that a policy change is beneficial if those who are better off could compensate those who are worse off, leading to a net increase in social welfare.

Question 4

Explain Scitovsky’s Paradox.

Answer 4

Scitovsky’s Paradox highlights a contradiction in the Kaldor-Hicks principle, where a move to a new state (C) is desirable, but a move back to the original state (G) could also be desirable using the same criteria.

Question 5

What is Arrow’s Impossibility Theorem?

Answer 5

Arrow’s Impossibility Theorem states that it is impossible to formulate a social welfare function that satisfies all the conditions of rational social choice, meaning it is difficult to make collective decisions that accurately reflect individual preferences.

Question 6

What are the three conditions for optimal resource allocation?

Answer 6

1) Marginal Rate of Substitution (MRS) between two commodities must be the same for any two consumers. 2) Marginal Rate of Technical Substitution (MRTS) between two inputs must be the same for any pair of producers. 3) MRS between two commodities must equal the Marginal Rate of Transformation (MRT) for any producer.