101-2011-L11 - Econ101 Lecture11 Aclosedeconomymodel...

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Econ 101 Lecture 11 A closed economy model
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Announcements n Today we will do Chapter 5, pages 154- 175 n Next time, we will do Chapter 5, pages  175-185, and start(?) Chapter  8    
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Competitive Equilibrium and  Pareto Optimum n Competitive Equilibrium n Pareto Optimum: it is impossible to  rearrange production and reallocate goods  in a way that someone is made better off  and no one else is made worse off N C l C l MP MRT MRS , , = =
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Finding the Pareto Optimum n Introducing a  fictitious character , the  social  planner : n The social planner is the nicest person on  earth: she wants to maximize consumers’  welfare.  She decides : n The firm’s production level and labor input n The consumer’s work and leisure n Division of consumption good between C and G
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Pareto optimum Finding the Pareto optimum Willingness to  substitute must equal  technological  possibility to  substitute, and both  must equal market  possibility to  substitute N C l C l MP MRT MRS , , = =
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§ We have just proved the two “fundamental theorems of welfare economics” in our  simple model Welfare Theorems 1. A competitive equilibrium is Pareto optimal (under certain conditions!) The free market interaction of self- interested consumers and firms produces an outcome that, before distributional considerations, is socially desirable: a benevolent invisible hand guides the actions of selfish agents Adam Smith (1723-1790)
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