Week 1 Reading - Hahn Flashcards
Why is the assumption of complete markets unrealistic?
Markets are not complete; for example, there are often no markets for contingent claims, meaning real economies don’t match the pure theory.
How does market power challenge the FFTWE?
When firms or individuals have market power, the invisible hand falters. Prices no longer reflect true scarcity or value, and Pareto efficiency breaks down.
What role does information asymmetry play in undermining the theorem?
Agents rarely have perfect information. When some agents know more than others, prices fail to convey accurate signals, leading to inefficient market outcomes.
What happens when rational expectations are introduced?
Even with rational expectations, there are often multiple equilibria — not all of which are Pareto efficient.
What is the ‘no-surplus condition,’ and why does it matter?
It’s the idea that no agent should have influence over prices. Without this, strategic behavior emerges, deviating from the pure competitive model.
How does the theorem handle externalities?
It doesn’t. When externalities are present, prices fail to reflect true costs or benefits, causing inefficiency and necessitating government intervention.
What is the key philosophical flaw in relying on the FFTWE as a policy guide?
Achieving a Pareto-efficient allocation doesn’t mean it’s fair or just; the distribution of welfare can be wildly unequal. Efficiency ≠ equity.
Why does the invisible hand sometimes ‘get stuck’?
Market dynamics don’t guarantee equilibrium. Miscalculations, imperfect information, and strategic behavior may cause suboptimal states.
How does the FFTWE relate to policy-making?
Hahn warns against using the theorem to justify laissez-faire policies without nuance; market failures often demand government intervention to correct inefficiencies.
How can you critically evaluate the FFTWE in an essay?
Start by explaining the theorem, discuss its unrealistic assumptions, highlight Hahn’s critiques, emphasize the distinction between efficiency and equity, and argue for adjustments in real-world policy.
