Class notes chap 3

Class notes chap 3 - welfare 6 The Second Fundamental...

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Chap 3: Tools of Normative Analysis 1. Welfare economics is the study of the desirability of alternative economic states. 2. A Pareto efficient allocation occurs when no person can be made better off without making another person worse off. Pareto efficiency requires that each person's marginal rate of substitution between two commodities equal the marginal rate of transformation. Pareto efficiency is the economist's benchmark of efficient performance for an economy. 3. The First Fundamental Theorem of Welfare Economics states that, under certain conditions, competitive market mechanisms lead to Pareto efficient outcomes. 4. Despite its appeal, Pareto efficiency has no obvious claim as an ethical norm. Society may prefer an inefficient allocation on the basis of equity or some other criterion. This provides one possible reason for government intervention in the economy. 5. A social welfare function summarizes society's preferences concerning the utility of each of its members. It may be used to find the allocation of resources that maximizes social
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Unformatted text preview: welfare. 6. The Second Fundamental Theorem of Welfare Economics states that society can attain any Pareto efficient allocation of resources by making a suitable assignment of initial endowments and then letting people freely trade with each other. 7. A second reason for government intervention is market failure, which may occur in the presence of market power or when markets do not exist. 8. The fact that the market does not allocate resources perfectly does not necessarily mean the government can do better. Each case must be evaluated on its own merits. 9. Welfare economics is based on an individualistic social philosophy. It does not pay much attention to the processes used to achieve results. Thus, although it provides a coherent and useful framework for analyzing policy, welfare economics is not universally accepted. Review Powerpoint slides and handout Do end of chapter problems 1, 4, 7, and 8...
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