Week 1 - First Fundamental Theorem Flashcards
What is positive political economy?
It involves efforts to understand how the world actually is.
What is normative political economy?
It focuses on the question of how the world should be.
What does welfare economics attempt to assess?
It attempts to assess the desirability of different economic outcomes.
What is the main standard used by neoclassical economists to evaluate outcomes?
Efficiency, which concerns the extent to which outcomes enable people to satisfy their preferences.
What does the first fundamental theorem of welfare economics relate to?
It relates to partial equilibrium analysis in a single market.
In the example of the market for used textbooks, what occurs at equilibrium?
In economics, equilibrium signifies a balanced state where economic forces like supply and demand are in balance, resulting in no tendency for change unless external factors intervene
What is consumer surplus?
The net gain enjoyed by individual buyers from their purchases in the market, equal to the sum of the differences between the price each buyer is willing to pay and the price they actually pay.
What is producer surplus?
The net gain enjoyed by individual producers from their sales in the market, equal to the sum of the differences between the price each supplier receives and the cost of providing the good.
What is total surplus?
The sum of consumer surplus and producer surplus, representing the total net benefit or gains from trade that consumers and producers enjoy.
What does a competitive market achieve?
It maximizes total surplus, producing an outcome that is Pareto efficient, meaning no one can be made better off without making someone else worse off.
What is partial equilibrium analysis?
The analysis of one market in isolation, ignoring inter-relations between that market and other markets.
What is general equilibrium analysis?
The study of the simultaneous equilibrium of several markets, considering the interdependencies between different markets.
What does the positive dimension of General Equilibrium Theory (GET) address?
The existence of a general economic equilibrium, questioning whether a set of prices can ensure simultaneous equilibrium in every market.
Who proved the logical possibility of a general economic equilibrium?
Kenneth Arrow and Gerard Debreu in the 1950s, using a mathematical model of interdependent markets.
What is the First Fundamental Theorem of Welfare Economics (1st FTWE)?
If there is a complete set of markets and all are perfectly competitive, then the equilibrium of that economy is Pareto efficient.
What does the Pareto criterion focus on?
Efficiency, excluding other normative issues like equity, and conceptualizing efficiency in terms of the satisfaction of people’s preferences.
What is market failure?
When the assumptions of a complete set of competitive markets are violated, leading to Pareto inefficiency.
Diagram: The welfare costs of monopoly
Monopolist produces output Qm that is less than the perfectly competitive level of output Qc ➔
failure to exploit all the scope for mutually advantageous trade, leading to a Pareto inefficient
outcome and a loss to society represented by the area C+E
What are externalites?
Externalities arise when the activities of one economic agent impinge directly upon the welfare
or production possibilities of other agents, where by ‘directly’ we mean that the influence is not
mediated via the market mechanism.
What is Pareto efficiency in relation to price and marginal social cost?
Pareto efficiency requires that the price of a good equals its marginal social cost.
If there is a negative externality, the level of output is such that price is less than marginal social cost, leading to Pareto inefficiency.
What are externalities?
Externalities are problems caused by missing markets, resulting in inefficient allocation of resources due to the absence of competitive markets for certain goods.
What are the attributes of public goods?
Public goods have two main attributes: non-rivalry in consumption and non-excludability.
What does non-rivalry in consumption mean?
Non-rivalry in consumption means one person’s consumption of a public good does not reduce the amount available for others.
What does non-excludability mean?
Non-excludability means that if a public good is provided for one person, others cannot be excluded from consuming it.
Why does the free market under-provide public goods?
The free market tends to under-provide public goods because rational consumers will attempt to free ride on others’ contributions.
What is the First Fundamental Theorem of Welfare Economics?
The First Fundamental Theorem of Welfare Economics states that under certain conditions, competitive markets lead to Pareto efficient outcomes.
What is required for a complete set of markets in an economy?
A complete set of markets requires a market for every physical good at every date in every possible state of nature.
What are contingent commodities?
Contingent commodities are goods defined in terms of the state of nature in which they are delivered, allowing people to insure against specific events.
What is the implication of bounded rationality in market completeness?
Bounded rationality implies that people may lack the ability to anticipate all possible contingencies, preventing the establishment of markets for those goods.
What are transactions costs?
Transactions costs are the costs associated with using markets, such as finding buyers/sellers and negotiating contracts.
What is asymmetric information?
Asymmetric information occurs when one party to a transaction has more information than another, undermining market efficiency.
What is the Chicago School of Economics’ perspective on market efficiency?
The Chicago School argues that free markets efficiently allocate resources, suggesting a minimal role for the state in economic activity.
What is the Tight Prior Equilibrium approach?
The Tight Prior Equilibrium approach posits that decision makers allocate resources such that no one can improve their expected utility without reducing another’s.
How do Chicago economists view market failure?
Chicago economists view market failure as an unusual situation, often alleging that monopoly is more frequently claimed than confirmed.
What does the 1st FTWE say about welfare properties of non-equilibrium states?
The 1st FTWE says nothing about the welfare properties of states of economy that are not equilibria.
What role do markets play according to the 1st FTWE?
The 1st FTWE neglects the role of markets in generating knowledge needed for a general equilibrium.
What distributional issues does the 1st FTWE ignore?
The 1st FTWE ignores distributional issues.
How does the 1st FTWE conceptualize people’s welfare?
The 1st FTWE conceptualizes people’s welfare in terms of preference satisfaction.
What is the first limitation of the 1st FTWE?
The first limitation is its focus on equilibria and inattention to disequilibrium adjustment.
What do heterodox schools of economics highlight about the 1st FTWE?
Heterodox schools of economics, such as the Austrian school, highlight that the 1st FTWE systematically ignores the benefits of markets.
What is Hayek’s view on knowledge in the economy?
Hayek argues that knowledge is dispersed among individuals, and no one person has access to all relevant facts.
What analogy does Hayek make regarding knowledge?
Hayek states that the division of knowledge is analogous to the division of labor.
What is the central problem of economics according to Hayek?
The central problem is how socioeconomic order is generated in market economies given subjective, dispersed knowledge.
What does Hayek argue is needed for understanding market economies?
Hayek argues for an empirical account of the disequilibrium causal processes through which knowledge is discovered and transmitted.
What role do market prices play according to Hayek?
Freely-formed market prices provide people with the knowledge needed to coordinate their plans.
What happens when entrepreneurs perceive new opportunities for tin?
Entrepreneurs purchase more tin, increasing demand and price, which informs others about its scarcity.
How does the market communicate information according to Hayek?
The market acts as a mechanism for communicating information, with prices as knowledge-surrogates.
What is the most significant fact about the economic system discussed?
The economy of knowledge with which it operates, requiring minimal knowledge from participants to take the right action.
How is essential information communicated in this economic system?
Only the most essential information is passed on, and only to those concerned.
What metaphor describes the price system according to Hayek?
The price system is likened to machinery for registering change or a telecommunications system for producers to monitor a few indicators.
What is the marvel of the economic system regarding resource scarcity?
Tens of thousands of people adjust their use of scarce materials without centralized direction or knowledge of the cause.
What conclusion does Hayek draw about the 1st FTWE?
The assumptions and conditions of the 1st FTWE no longer provide an appropriate basis for assessing market merits.
What does Hayek deny about market competition?
He denies that markets must be perfectly competitive to function effectively.
What is a flaw in general equilibrium theory according to Hayek?
It focuses on equilibria where supply and demand are reconciled, ignoring the role of competition in discovering information.
What does Hayek argue about the assumptions of perfect competition?
These assumptions overlook the merits of markets, particularly how competition encourages the discovery of new goods and production methods.
What activities does Hayek believe are excluded from the theory of perfect competition?
Activities such as setting prices to undercut competitors, offering new products, and developing cost-reducing technologies.
How should markets be evaluated according to Hayek?
Markets should be judged not against an ideal state of general equilibrium but by outcomes produced by non-market resource allocation methods.
What is the peculiarity of competition according to Hayek?
Its performance is not tested in specific instances but is shown by the market prevailing against alternative arrangements.
What does Hayek say about judging the market?
We do injustice to the market’s achievements if we compare it to an ideal standard we cannot achieve.
What is Hayek’s focus in his analysis?
He seeks to shift attention to comparative institutional analysis.
