Week 1 - First Fundamental Theorem

Question 1

What is positive political economy?

Answer 1

It involves efforts to understand how the world actually is.

Question 2

What is normative political economy?

Answer 2

It focuses on the question of how the world should be.

Question 3

What does welfare economics attempt to assess?

Answer 3

It attempts to assess the desirability of different economic outcomes.

Question 4

What is the main standard used by neoclassical economists to evaluate outcomes?

Answer 4

Efficiency, which concerns the extent to which outcomes enable people to satisfy their preferences.

Question 5

What does the first fundamental theorem of welfare economics relate to?

Answer 5

It relates to partial equilibrium analysis in a single market.

Question 6

In the example of the market for used textbooks, what occurs at equilibrium?

Answer 6

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

Question 8

What is consumer surplus?

Answer 8

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.

Question 9

What is producer surplus?

Answer 9

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.

Question 10

What is total surplus?

Answer 10

The sum of consumer surplus and producer surplus, representing the total net benefit or gains from trade that consumers and producers enjoy.

Question 11

What does a competitive market achieve?

Answer 11

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.

Question 12

What is partial equilibrium analysis?

Answer 12

The analysis of one market in isolation, ignoring inter-relations between that market and other markets.

Question 13

What is general equilibrium analysis?

Answer 13

The study of the simultaneous equilibrium of several markets, considering the interdependencies between different markets.

Question 14

What does the positive dimension of General Equilibrium Theory (GET) address?

Answer 14

The existence of a general economic equilibrium, questioning whether a set of prices can ensure simultaneous equilibrium in every market.

Question 15

Who proved the logical possibility of a general economic equilibrium?

Answer 15

Kenneth Arrow and Gerard Debreu in the 1950s, using a mathematical model of interdependent markets.

Question 16

What is the First Fundamental Theorem of Welfare Economics (1st FTWE)?

Answer 16

If there is a complete set of markets and all are perfectly competitive, then the equilibrium of that economy is Pareto efficient.

Question 17

What does the Pareto criterion focus on?

Answer 17

Efficiency, excluding other normative issues like equity, and conceptualizing efficiency in terms of the satisfaction of people’s preferences.

Question 18

What is market failure?

Answer 18

When the assumptions of a complete set of competitive markets are violated, leading to Pareto inefficiency.

Question 19

Diagram: The welfare costs of monopoly

Answer 19

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

Question 20

What are externalites?

Answer 20

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.

Question 21

What is Pareto efficiency in relation to price and marginal social cost?

Answer 21

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.

Question 22

What are externalities?

Answer 22

Externalities are problems caused by missing markets, resulting in inefficient allocation of resources due to the absence of competitive markets for certain goods.

Question 23

What are the attributes of public goods?

Answer 23

Public goods have two main attributes: non-rivalry in consumption and non-excludability.

Question 24

What does non-rivalry in consumption mean?

Answer 24

Non-rivalry in consumption means one person’s consumption of a public good does not reduce the amount available for others.

Question 25

What does non-excludability mean?

Answer 25

Non-excludability means that if a public good is provided for one person, others cannot be excluded from consuming it.

Question 26

Why does the free market under-provide public goods?

Answer 26

The free market tends to under-provide public goods because rational consumers will attempt to free ride on others' contributions.

Question 27

What is the First Fundamental Theorem of Welfare Economics?

Answer 27

The First Fundamental Theorem of Welfare Economics states that under certain conditions, competitive markets lead to Pareto efficient outcomes.

Question 28

What is required for a complete set of markets in an economy?

Answer 28

A complete set of markets requires a market for every physical good at every date in every possible state of nature.

Question 29

What are contingent commodities?

Answer 29

Contingent commodities are goods defined in terms of the state of nature in which they are delivered, allowing people to insure against specific events.

Question 30

What is the implication of bounded rationality in market completeness?

Answer 30

Bounded rationality implies that people may lack the ability to anticipate all possible contingencies, preventing the establishment of markets for those goods.

Question 31

What are transactions costs?

Answer 31

Transactions costs are the costs associated with using markets, such as finding buyers/sellers and negotiating contracts.

Question 32

What is asymmetric information?

Answer 32

Asymmetric information occurs when one party to a transaction has more information than another, undermining market efficiency.

Question 33

What is the Chicago School of Economics' perspective on market efficiency?

Answer 33

The Chicago School argues that free markets efficiently allocate resources, suggesting a minimal role for the state in economic activity.

Question 34

What is the Tight Prior Equilibrium approach?

Answer 34

The Tight Prior Equilibrium approach posits that decision makers allocate resources such that no one can improve their expected utility without reducing another's.

Question 35

How do Chicago economists view market failure?

Answer 35

Chicago economists view market failure as an unusual situation, often alleging that monopoly is more frequently claimed than confirmed.

Question 36

What does the 1st FTWE say about welfare properties of non-equilibrium states?

Answer 36

The 1st FTWE says nothing about the welfare properties of states of economy that are not equilibria.

Question 37

What role do markets play according to the 1st FTWE?

Answer 37

The 1st FTWE neglects the role of markets in generating knowledge needed for a general equilibrium.

Question 38

What distributional issues does the 1st FTWE ignore?

Answer 38

The 1st FTWE ignores distributional issues.

Question 39

How does the 1st FTWE conceptualize people's welfare?

Answer 39

The 1st FTWE conceptualizes people's welfare in terms of preference satisfaction.

Question 40

What is the first limitation of the 1st FTWE?

Answer 40

The first limitation is its focus on equilibria and inattention to disequilibrium adjustment.

Question 41

What do heterodox schools of economics highlight about the 1st FTWE?

Answer 41

Heterodox schools of economics, such as the Austrian school, highlight that the 1st FTWE systematically ignores the benefits of markets.