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Unformatted text preview: 1 Lecture 6M Part IIa: Paper 1 General Equilibrium and Welfare Economics Dr Marco van der Leij Office Hour: Tuesday 1011 am 2 Outline: Efficiency and Equity Efficiency vs Equity and the Second Fundamental Theorem Cowell Ch. 9.39.3.2 Varian Ch. 31.13, First Best vs Second Best Cowell 13.7 Lump sum taxes 3 Second Fundamental Theorem If assumptions 1 to 3 hold, then any Pareto efficient allocation can be achieved by appropriate redistribution through an Ideal LumpSum Tax and leaving the competitive market to find prices. 4 FT2 in an Exchange Economy O A O B x y e 1 B x A x e e + B y A y e e + e 2 Initial endowment Competitive equilibrium, no intervention Competitive equilibrium that maximises SWF SWF* To achieve SWF*, tax is imposed on individual As endowment, and this is transferred to individual B Tax and transfer are lumpsum since value of endowment is taken as given by each individual NonConvexity of indifference curves x y p A B Pareto Efficient Not supported by competitive equilibrium 6 Implications of FT2 Decentralisation result: redistribute with limited government informational requirements decentralised decisions will lead to a firstbest Pareto allocation (satisfy the marginal conditions) Separate out equity from efficiency: any point on the Pareto frontier can be achieved. there is no conflict between redistribution and achieving a firstbest Pareto allocation 7 Implications There are two distinct reasons for government intervention (under the assumptions of the FT2) : 1. To redistribute: competitive market may not lead to the Pareto efficient point that maximises social...
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 Spring '12
 Reiche
 Economics

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