efficiency - Efficiency Jeffrey Ely April 6 2015 This work...

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Efficiency Jeffrey Ely April 6, 2015 This work is licensed under the Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License . Jeffrey Ely Efficiency
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Recap We saw last time that any standard of social welfare is problematic in a precise sense. If we want to proceed, we need to compromise in some way. We must abandon one of the basic principles 1 Universal Domain 2 Pareto 3 Independence of Irrelevant Alternatives Jeffrey Ely Efficiency
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Pareto 1 Pareto is the criterion most closely tied to social welfare. 2 So we will insist on Pareto 3 What if we only require Pareto? Jeffrey Ely Efficiency
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Pareto Dominance Definition Alternative A Pareto dominates another alternative B if every individual prefers A to B , i.e. A i B for every individual i . 1 Pareto dominance is a way of ranking alternatives. 2 But it is an incomplete ranking: often neither alternative Pareto dominates the other. 3 Examples: 1 The last remaining basketball ticket. 2 Public school assignment. 3 Designer dress dibs. Jeffrey Ely Efficiency
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Pareto Efficiency So Pareto dominance rarely gives us a clear ranking But when it does, the prescription couldn’t be more compelling. Definition An alternative A is Pareto efficient if there is no B that Pareto dominates it. Jeffrey Ely Efficiency
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Building on Pareto Efficiency We should not choose any alternative which is Pareto dominated. This is a foundational principle of Economics. The remaining question is how to build an overall social ranking which puts Pareto efficiency at the top. Arrow’s Theorem says that this is problematic. Jeffrey Ely Efficiency
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Restricted Domains But in many economic contexts there is a way out. Jeffrey Ely Efficiency
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A Way Out 1 Let’s revisit the example with the basketball ticket. 2 Let’s suppose we also have the possibility of enforcing monetary transfers. 3 How much money are you willing to pay to have the ticket? Jeffrey Ely Efficiency
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Willingness to Pay Thought experiment. Pile of money. Basketball ticket. How large can we make the pile of money before you take the money rather than fly? We equate that with your willingness to pay. Jeffrey Ely Efficiency
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Willingness to Pay Willingness to pay adds more information about your preferences. Before we just talked about your ranking of A versus B . Now we can say something about how much more you like A than B . How much money would it take to get you to favor B over A ? Truthfully. Jeffrey Ely Efficiency
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Pareto Dominance When Money’s Involved Remember that any allocation of the ticket is Pareto efficient. Suppose we are going to give the ticket to j but i has a higher willingness to pay. Consider now the following new alternative. 1 We give the ticket to i instead of j . 2 We take an amount of money x from i and transfer it to j .
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