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Unformatted text preview: neral Equilibrium: if we can ascertain that there exists such an equilibrium price, then how do we proceed to find it? The question of Pareto Theory is ... after we get an equilibrium price vector ... [1] Is this equilibrium price vector the "best" one for the economy? [2] Is the Walrasian general equilibrium solution the "best" way to allocate resources in the economy? [3] Can we get the "best" allocation of resources in the economy without going through a general equilibrium solution? [4] Can we find all of the "best" allocations of resources in the economy? Now, to answer any of these questions, we need to understand what is meant be the word "best" and this is exactly the question which Pareto Optimal Theory is trying to clarify. The theory suggests the notion of "Pareto Optimality" or "Pareto Efficiency" which can be stated as follows: An allocation is Pareto Optimal if no one can be made better off without making someone worse off. So this is an awkward statement, isn't it? To clarify, if someone can be made better off while no one else is worse off then the allocation can be improved. Of course, if the allocation can be improved then it cannot be the best allocation, and hence, is not Pareto Optimal. 155 On the other hand, if someone can be made better off only when someone else has to be made worse off then the allocation cannot be further improved. Of course, if the allocation cannot be further improved then, by definition, it is the best allocation i.e. it is Pareto Optimal. So let's incorporate the concept of Pareto Optimality into the pure exchange economy. It is essentially the same problem that we had before except now we need to satisfy the following two conditions: [1] The quantities of goods allocated must equal the quantity of goods available (feasibility). XA + XB = X YA + YB = Y (1) (2) [2] The allocation must be Pareto Optimal in the sense that no one can be made better off without making someone else worse off. EDGEWORTH BOX First, we need to know what an Edgeworth Box is... We will do this a little diff...
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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.

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