IMCH18Wnew07 - Chapter 18W General Equilibrium and Market...

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Chapter 18W General Equilibrium and Market Efficiency Chapter Summary Chapter 18W presents the idea of general equilibrium. The Edgeworth box is used to illustrate a simple general equilibrium model with resources taken as given. Next the model accounts for production. Gains from trade are illustrated, and taxes are included. The chapter concludes with a discussion of factors which might lead to inefficiency: monopoly, externalities, and public goods. Chapter Outline Chapter Preview A Simple Exchange Economy Only Relative Prices Are Determined Efficiency in Production Gains from International Trade Taxes in General Equilibrium Other Sources of Inefficiency Summary Teaching Suggestions 1. This is the one place where the economist can play philosopher. What is the "good life" and how can it be maximized? The contrast between the Pareto optimal notion of no one being hurt and the utilitarian approach of the greatest overall good will usually stimulate thinking on the welfare issues. Point out how conservative the Pareto optimal approach tends to be since no changes can be carried out if someone is offended. On the other hand, the utilitarian approach is impossible to make operational because there is no good measure of the pain and pleasure experienced in everyday transactions except what can be observed in the transactions themselves. Because people will bias their estimates of pain and pleasure toward their interests, the two views converge when a voluntary exchange system is involved. It might be worth asking whether there is a difference between the end-state utility maximization concepts of Pareto optimal analysis and the process- oriented approach of the libertarian who cares mostly about clearly defined rules of the game. Since Pareto optimality depends on free exchange and correct prices, is it not really a process- oriented approach of which maximum welfare is a by-product? Whether or not there is time to wax philosophical, it is important to point out that Pareto optimality is a good fit for a system based on revealed preference and that it is concerned with welfare understood in efficiency terms rather than with welfare in a broader sense where fairness is part of one's view of welfare. 2. For many students, this will be the first Edgeworth box and contract curve they have seen. The place to start is with the three conditions for efficient allocation rather than the graphics. It is not hard to intuitively illustrate why consumers can benefit from exchange if they value commodities differently on the margin. Likewise, it is easy to show why two different inputs can be exchanged profitably if they have differing marginal productivities in two separate production operations. We already have studied these cost minimization requirements in an earlier chapter. Finally, students can see that we can be producing goods at least cost and consumers might have exchanged the goods so that the items are all in their best use, but the goods produced might not be the ones that should be produced. If the MC of producing a
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This note was uploaded on 09/16/2011 for the course ECON/ACCOU 101 taught by Professor Jang,hajoon during the Spring '11 term at Korea University.

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IMCH18Wnew07 - Chapter 18W General Equilibrium and Market...

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