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Schotter - Ch 15 - 5I4 CIiAP'IIR 15 GINERcfw_I...

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5I4 CIiAP'IIR 15 GINER{I IQLILIBRIUM,{\D THB ORIGINS OF TIIE FREI.MARKIT 15.1 THE FRIE-TIA,RKLT AIIGUMENT The free-market aryunent stans with the assunplion that al one point ilr Line there is an existing econoinywith a given slock of capital and labor aDd large numbers of people who tunctlon as boih prcducers and consurners. All the consumcrs havc convex nrditrer- ence curves. whlch indicate a decreasing narginal rate of subdilution bctween goods. All the producers have convex isoquants, which hdicate a dccreasirg marginal rate of iechnical substitution belween inputs. To sinplify ouldiscussioD, wc will futher assune ihat ihere are only two people in the econorny, pe.son I and pcrson 2, !fti thrt thc econ- oltly pladuces only two goods, good 1 and good 2. These assmlplions lrJc mc.cly a con- venjence and will not rcstrict our analysis in any way. The problems thal lhe econony nust solvc rre: (l) how to allocate the existing stock of capiial and labor efficicndy bctwcen the produclion ofgood I and the produc' tion ofgood 2, which rvill deLenniie how nuch ofeach good is produced. aDd (2) how !o djstribule ihese goods eficiently anong the populatrnr once they ar€ lroduced. When we refer to efficiencyhere, we mean Pareto efficiencJ. An allocation of iDpuls (capiial and labor) is Pareto'eflicicnt if it is not possible to reallocate these jnputs dnd produce more of al leasr one good ni the economy without decreasing the amount of someother good that is produced. Srniliirly. a distrjbution of goods is Pafeto-efficient if it is nor possible 1() rcdistibute these goods and make at least one pefson in the economy belter offin lerms ofutility without naking someone else wofse off. The free-market aqumcnt rcsts on three beliefs: L Perfect competiiionwill allocate inputsto the producrion ofgoods in an emcienr 2. Once goodsare produced. lhey will be distdbuted in an eflicient manner by the forcesof supply and demand in competitive markets. 3. Tlle finat mix ofgoods pmducedwill be deiernrined by the distribution ofincome generaied by the competitive marketprocessi whatever the final mix ofgoods tums out io be. these goodswill be distributed among the popuLatjon in an elficient manner. Let us now review the various stages in the fiee-market argumenl one by one. We will begin by describing the conditions thal must be satisJied to ensure the efficient distribulion of goods once lhey have been produced. We will then discuss the condi- tions that must be satisfied to ensure the efficient allocal;on of inputs to production. Finally. we will prove that a set of perfectly competitive markets will exacdy satisfy such conditions. This result is the basis of th€ argunent of free market advocales that governmentinlerttrence with the competitive process may reduce the efficiencyof Efficiency in Consumption In Chapler ,1.
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