Section 05 _Efficiency, Gains from Trade, and Welfare Economics_

Section 05 _Efficiency, Gains from Trade, and Welfare Economics_

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1 Efficiency, Gains from Trade, Welfare Economics, and more on equilibrium (Section 5) I. Efficiency Dictionary Definition - Comparing production with costs (inputs). - Much of public finance discusses and analyzes efficiency; thus it is important to have a precise meaning A. Technical vs. Economic Efficiency
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2 B. Pareto Efficiency Pareto Efficiency - A situation is Pareto efficient if the only way to make someone better off is make someone else worse off. (If the only way to make someone better off is to make someone worse off the situation is Pareto efficient) Pareto Improvement - A change that makes someone better off without making anyone worse off. - Are Pareto improvements possible? Watch example C. Kaldor-Hicks Efficiency (cost-benefit analysis) Kaldor- Hicks Efficient - A situation is K-H efficient if the dollar value of the social resources are maximized (If the dollar value of the social resources are maximized a situation is K- H efficient) Kaldor –Hicks Improvement - Any change that raises the dollar value of social resources.
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3 - Every K-H efficient situation is Pareto efficient, but most Pareto efficient situations are not K-H efficient. Ex - Cell phone Ray values the cell phone at $40 Frat values the cell phone at $60 All the strangers Ray encounters value Ray having the cell phone at $1 (total for all) [assume we don’t know who these people are] All the strangers Frat encounters value Frat having the cell phone at $1 (total for all) [assume we don’t know who these people are] 1. If Frat has the cell phone is the situation PE and K-H.E.? Why 2. If Ray has the cell phone is the situation PE and K-H.E.? Why - Every Pareto improvement is K-H improving but most K-H improvements are not Pareto improving. Ex - Cell phone
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4 - K-H improvement can be called potentially Pareto improving, you could compensate losses with gain in surplus. What does this mean? Ex- Monopoly [If move from a Monopoly to a competitive market is this: K-H improving? P.I?]
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5 D. Kaldor- Hicks and Deadweight loss Deadweight loss - Value of social resources is not maximized. 1. Transfer of resources vs. resources destroyed Ex - Pirates - A Pirate transfers items from others to himself, in this there is no loss to society. (if we assume pirates value goods as much as original owners) Where is the deadweight loss? What are we forgetting to add ? Notes: 1) When examining benefits and costs it depends on what direction you look at something, a benefit in one direction is a cost in another. 2) Net Benefit = Benefits – Costs ( NB = B- C)
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6 Note: It depends on what direction you look at something: (a benefit in one direction is a cost in the other) Net Benefit = Benefit – Costs ( Δ NB = Δ Ben – Δ cost) Ex - Drug Legalization vs. Non-legal drugs (Landsburg Handout (Handout 1)) - Transfer, benefit, or deadweight loss? 1)
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This note was uploaded on 12/27/2011 for the course ECON 302 taught by Professor Ahmad,y during the Fall '08 term at Wisc Whitewater.

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Section 05 _Efficiency, Gains from Trade, and Welfare Economics_

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