Welfare economics

Question 1

What is a resource allocation

Answer 1

A resource allocation is a complete description of who does what, and who gets what, within an economy

Question 2

What is meant by pareto superior and pareto efficient?

Answer 2

A resource allocation, X, is said to be Pareto Superior (PS) to another resource allocation, Y, if every individual is at least as well off in X compared to Y, and at least one person is strictly better off in X

• An allocation is Pareto Efficient (PE) if there exists no other feasible allocation that is Pareto Superior to it. Hence a PE allocation is one at which no individual can be made better off without making at least one person worse off. Allocations that are not PE are Pareto Inefficient (PI).

Question 3

Explain general equillibirum analysis

Answer 3

Used in order to study all markets simultaneously

Allows for interactions between different markets

If we consider two consumers and two goods in a pure exchange economy, i.e. no production

A pair of bundles one for each consumer is called an allocation

AN allocation is feasible if total amount of each good being consumed is equal to the total amount available

x_{1a +}x_2a = w_1a + w_2b

Question 4

What is an edgeworth box?

Answer 4

Summarises all this information within a simple diagram

Construct a box whose width and height correspond to the toal endownmnet in the economy of good a abd b respecitively

Question 5

what is efficiency in edgeworth box?

Answer 5

Question 6

What is the contract curve?

Answer 6

Question 7

What is competitive genenral equllibrium?

Answer 7

A GCE consists of a set of prices (Pa,Pb) one for each good, such that each consumer is acting optimally given these prices, and all consumer’s choices are compatible in the sense that demand equals supply in each market.

Question 8

Explain disequilbirum prices

Answer 8

Question 9

Explain equilibirum prices

Answer 9

Consumer 1 optimum:

MRS¹ _b,a = -pa/pb

Consumer 2 optimum:

MRS² _b,a = -pa/pb

Hence at CGE: MRS¹ _b,a = MRS² _b,a ( = -pa/pb)

Question 10

What is the first fundamental theorem of welfare economics?

Answer 10

In absence of any disortions all GCE’s are pareto efficient

Question 11

Second fundamental theorem of welfare ecomomics

Answer 11

The Second Fundamental Theorem (SFT) states that if all agents have convex preferences, then there will always be a set of prices such that each Pareto efficient allocation can be established as a competitive equilibrium given an appropriate assignment of endowments achieved via lump sum taxation

An important interpretation of this result is that it is possible to separate the goals of efficiency and fairness (i.e. if the SFT holds both objectives can be achieved – no trade off

issue however are that how does the government know necessary levels of taxation

redistribution is assumed to oocur via ‘lump sum’ taxation meaning taxation that is independednt of any choices agents make

in practice this is rare, so efficiency is endangered