Unformatted text preview: ot Pareto efficient. Therefore, this assumption must be wrong. Thus, if an allocation bundle x is a competitive equilibrium then the allocation bundle x is Pareto Optimal. This result is known as the First Fundamental Theorem of Welfare Economics. THE FIRST FUNDAMENTAL THEOREM The First Fundamental Theorem of Welfare Economics provides the link which connects the Walrasian General Equilibrium Theory to the Pareto Optimal Theory. On one hand, Walrasian Theory deals with the various concepts of equilibrium. On the other hand, Pareto Theory deals with the various concepts of efficiency. The First Fundamental Theorem of Welfare Economics essentially says that "the Walrasian concept of general equilibrium is consistent with the Pareto concept of efficiency". So what does this mean in the context of our Pure Exchange Economy? We have studied both the Walrasian general equilibrium pure exchange economy and the Pareto optimal pure exchange economy with two goods (X,Y) and two consumers (A,B). Let's summarize what we know so far... WALRASIAN PURE EXCHANGE The Walrasian pure exchange model provides equilibrium prices (PX, PY) and allocation (XA, XB, YA, YB) such that (a) both consumers are in equilibrium (indifference curves are tangent to budget lines) (b) both markets are in equilibrium (demands equal supplies) PARETO OPTIMAL PURE EXCHANGE The Pareto Optimal pure exchange model provides optimal allocations (XA, XB, YA, YB) such that (a) no one can be made better off without making the other worse off (indifference curves are tangent to each other) (b) both goods are fully allocated (quantities distributed equal the quantities available) 198 In general, the First Fundamental Theorem of Welfare Economics provides a bridge from the Walrasian theory to the Pareto theory. For our exchange economy, we have the following specific statement of the First Fundamental Theorem of Welfare Economics: If the general equilibrium conditions of the Walrasian pure exchange economy are satisfied then the optimal conditions of the Pareto Optimal pure exchange economy are also satisfied. Let's look at the equilibrium conditions of the Walrasian GE pure exchange model and the optimal conditions of the Pareto Optimal pure exchange economy side-by-side:
WALRASIAN PURE EXCHANGE PARETO OPTIMAL PURE EXCHANGE (EQUILIBRIUM CONDITIONS) Consumer Equilibrium for Person A MRSA = PX PY PXXA + PYYA = MA Consumer Equilibrium for Person B MRSB = PX PY PXXB + PYYB = MB Market equilibrium...
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.
- Spring '10