07. Consumption Externalities Notes

07. Consumption Externalities Notes - ECON 201 Shomu...

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Unformatted text preview: ECON 201 Shomu Banerjee CONSUMPTION EXTERNALITIES & INEFFICIENCY The First Fundamental Welfare Theorem that we studied earlier states that : Under fairly weak assumptions 1 about consumer preferences, at a Walrasian equilibrium, the allocation attained is Pareto efficient and individually rational . 2 As stated, this statement is not exactly true; it is only true so long as (a) all market are Walrasian (perfectly competitive) and there is no imperfect competition (b) there are no public goods (c) there are no externalities (d) there are no information asymmetries, and (e) there are no non-convexities. 3 The aim of this note is to present an example where the First Fundamental Welfare Theorem fails when there is a negative consumption externality. Suppose A and B are the only two consumers in our economy, there are two goods x and y , and A ’s endowment is ω a = (0, 1) while B ’s is ω b = (1, 0). Further suppose that their utility functions are given by u A ( x a , y a , x b ) = x...
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07. Consumption Externalities Notes - ECON 201 Shomu...

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