3 welfare economics - Welfare economics Now we move to a...

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Welfare economics Now, we move to a more systematic perspective on government. A minimal gov’t only protects property rights. Modern gov’t certainly does more things than that. Why? Two reasons are given by welfare economists to justify gov’t’s role beyond its minimal function: – Efficiency – Equity PDF created with pdfFactory trial version
Two fundamental theorems in welfare economics 1st theorem: handles efficiency 2nd theorem: handles equity – Unfortunately, both theorems are frequently misunderstood. PDF created with pdfFactory trial version
The message of the 1st theorem is sometimes difficult to learn Because the argument is not given directly. It does not say: doing these, the gov’t makes the economy more efficient. It says: under some conditions, the gov’t cannot do anything to make the economy more efficient. PDF created with pdfFactory trial version
What is Efficiency? Pareto efficiency (PE): A social state. It is impossible to improve someone while no one is worse off by moving away from this state. For an economy with exchange and production sectors, PE requires at the same time – Exchange efficiency – Production efficiency – Product-mix efficiency PDF created with pdfFactory trial version
Exchange Efficiency A simple exchange economy: – 2 person: A, B – 2 goods: X, Y Before exchange, people are “endowed” with some X and Y. Preferences for X,Y represented by indifference curves PDF created with pdfFactory trial version
Y Y U B 2 U B 1 U A 2 U A 1 O A X O B X PDF created with pdfFactory trial version
Edgeworth Box X B O B Y B M Y A O A X A PDF created with pdfFactory trial version
Consumer’s Interest in the Box X B O B U B 2 U B 1 Y B Y A U A 1 U A 2 O A X A PDF created with pdfFactory trial version
Pareto Improvement: At least one person better off, no one worse off X B O B Q R Y B Y A U B 0 U A 1 U A 2 O A X A PDF created with pdfFactory trial version
Exchange Efficiency EE: When PI is no longer possible by exchange. U B 1 X B O B U B 0 Q R E Y B Y A U A 2 U A 1 O A X A T PDF created with pdfFactory trial version
Efficient Outcomes are usually not unique U B 1 X B O B U B 0 Q U B 1 E Y B Y A W U A 2 U A 1 O A X A PDF created with pdfFactory trial version
Efficiency vs. Efficient condition

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