Week 7 - Market Failure

Question 1

When does market failure occure

Answer 1

When resources are not allocated efficiently

Question 2

Why/when is voluntary trade good?

Answer 2

Under some circumstances, voluntary trade will be a Pareto improvement as otherwise they would not agree to it.

This is true whenever no 3rd parties are involved.

Question 3

Explain the invisible hand theorem

Answer 3

Under some circumstances, a competitive equilibrium allocation will be Pareto improvement.

Question 4

When is the invisible hand theorem true?

Answer 4

True when there is a complete set of markets, all agents are price takers, there is a finite number of firms and commodities and the outcome will be Pareto efficient.

Question 5

Explain the complete set of markets

Answer 5

There is a market for every relevant commodity including for appropriate financial securities and pollution. This is a very unrealistic assumption as imperfect competition, externalities and asymmetric information result in missing markets.

Question 6

Explain the 2nd fundamental theorem of welfare

Answer 6

Any Pareto efficient allocation can be implemented as competitive equilibrium after some redistribution. lump sum transfers are non-distortionary.

Question 7

When in the 2nd fundamental theorem of welfare true?

Answer 7

True if:

• all agents are price takers
• there’s a complete set of markets
• preferences are convex
• production sets are complex