lecture12_slides

lecture12_slides - Econ 121 Intermediate Microeconomics...

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Econ 121. Intermediate Microeconomics. Eduardo Faingold Yale University Lecture 12
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Outline of the course I. Introduction II. Individual choice III. Competitive markets IV. Market failure
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Outline of the course I. Introduction II. Individual choice III. Competitive markets ± Exchange economies (Ch. 31) IV. Market failure
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Primitives of the model ± Two consumers, labeled A and B ; two goods, labeled 1 and 2 ± Consumer A ’s bundle: .x A 1 ; x A 2 / ± Consumer B ’s bundle: .x B 1 ; x B 2 / ± Utility functions: u A .x A 1 ; x A 2 / and u B .x B 1 ; x B 2 / , for A and B , respectively ± Endowments: ! A D .! A 1 ; ! A 2 / , ! B D .! B 1 ; ! B 2 / ± Net supplies: ! 1 D ! A 1 C ! B 1 ; ! 2 D ! A 2 C ! B 2 :
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Feasible allocations An allocation is a vector x D ..x A 1 ; x A 2 /; .x B 1 ; x B 2 // , that is, a consumption bundle for each consumer. An allocation x is feasible if x A ` C x B ` D ! ` ; for ` D 1; 2: Feasible allocations can be viewed as points in the Edgeworth box .
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x A 1 Edgeworth box x B 1 x A 2 x B 2 w 1 w 2
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A B x 1 A x 2 B x 1 B x 2 A u A = const u B = const Indifference curves in the Edgeworth box
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Goal of analysis We address the following questions: 1. Which allocations can emerge as outcomes of some efficient trading process ? 2. Which allocations would a social planner like to implement? 3. Which allocations can emerge as outcomes of some decentralized, competitive market ? 4. Which policies can a social planner introduce to induce a desirable market outcome?
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Pareto efficiency An allocation x is Pareto dominated by an allocation x 0 if for each consumer i D A; B , u i .x 0 i 1 ; x 0 i 2 / ² u i .x i 1 ; x i 2 /; with strict inequality for some consumer i . A feasible allocation is Pareto efficient if there does not exist a feasible allocation x 0 that Pareto dominates x .
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Pareto efficiency Two equivalent interpretations of Pareto inefficiency: ± Gains from trade: if an allocation x is Pareto inefficient, there are mutually beneficial gains from trade. Thus, we “expect” A and B to negotiate some mutually beneficial terms of trade that would make them both better off at some allocation other than x . ± Social planner: if an allocation x is Pareto inefficient, a benevolent social planner would not like to implement that allocation, as he can find some other allocation that makes all agents weakly better off, and at least some agent strictly better off.
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x A 1 A Pareto improvement x B 1 x A 2 x B 2 w 1 w 2
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Pareto efficiency In the Edgeworth, can plot the set of Pareto efficient allocations. This set is called the contract curve .
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