TOOLS OF NORMATIVE ANALYSIS Chapter 3 Welfare Economics
- Slides: 25
TOOLS OF NORMATIVE ANALYSIS Chapter 3
Welfare Economics Concerned with the social desirability of alternative economic states. 3 -2
Consumption Economy • Edgeworth Box - an analytical device used to model welfare economic theory • Depicts distribution of goods in a 2 -good/2 -person economy • Pareto Efficiency – an allocation of resources such that no person can be made better off without making another person worse off • Pareto Improvement – a reallocation of resources that makes at least one person better off without making anyone else worse off 3 -3
Edgeworth Box 2 person / 2 good economy y Eve 0’ Fig leaves per year r v u w At “v”, how many apples and figs do Adam and Eve consume? 0 Adam s x Apples per year 3 -4
Indifference curves in Edgeworth Box Eve r 0’ E 1 Fig leaves per year E 2 E 3 A 2 0 Adam A 1 s Apples per year 3 -5
Beginning at Point g, how to make Adam better off without Eve becoming worse off Eve r 0’ Fig leaves per year Eg g h A Pareto Efficient Allocation p Ap Ah Ag 0 Adam s Apples per year 3 -6
Beginning at Point g, how to make Eve better off without Adam becoming worse off Eve r 0’ Fig leaves per year Eg g p Ep 1 A Pareto Efficient Allocation Ag 0 Adam s Apples per year 3 -7
Beginning at Point g how to make both Adam and Eve better off Eve r 0’ Fig leaves per year Eg g • Pareto efficient • Pareto improvement Ep 2 p p 1 Ap 2 Ag 0 Adam s Apples per year 3 -8
Starting from a different initial point: Point k Eve 0’ r Fig leaves per year Eg g k Ep 2 p 3 p 4 p p 2 p 1 Ap 2 Ag 0 Adam s Apples per year 3 -9
The Contract Curve Eve r Fig leaves per year Eg 0’ g The contract curve – locus of all Pareto efficient points p 4 Ep 2 p p 3 p 1 Ap 2 Ag 0 Adam s Apples per year 3 -10
Pareto Efficiency in Consumption Adam MRSaf = MRSaf Eve Where MRS: -is the rate at which an individual is willing to trade one good for another -is the absolute value of the slope of an indifference curve 3 -11
Production Economy • Analysis when supplies of 2 goods (applies and figs) are variable rather than fixed • Production Possibilities Curve – Graph to model production economy – Maximum quantity of one output that can be produced given the amount of the other output 3 -12
Fig leaves per year Production Possibilities Curve C │Slope│ = marginal rate of transformation w y 0 C x z Apples per year 3 -13
Marginal Rate of Transformation • MRTaf = Marginal rate of transformation of apples for fig leaves • MRTaf = rate at which the economy can transform one good into another • MRTaf = Absolute value of slope of Production Possibilities Frontier • MRTaf = MCa/MCf 3 -14
Pareto Efficiency Conditions with Variable Production Adam • MRTaf = MRSaf Adam Eve • MCa/MCf = MRSaf Eve 3 -15
The First Fundamental Theorem of Welfare Economics • Given: – All producers and consumers are perfect competitors – A market exists for every commodity • Then a Pareto Efficient allocation of resources emerges – A competitive economy allocates resources efficiently out any need for centralized direction 3 -16
The First Fundamental Theorem of Welfare Economics Adam • MRSaf = Pa/Pf Consumption Side Eve • MRSaf = Pa/Pf Adam • MRSaf = MRSaf Eve • MCa/MCf = Pa/Pf Production Side • MRTaf = Pa/Pf • Pa/Pf = MCa/MCf 3 -17
Fairness and Second Fundamental Theory of Welfare Economics • Addresses equity concerns in allocations of goods • Second Fundamental Theory of Welfare Economics states that society can attain any Pareto efficient allocation of resources – one that is more equitable – by redistributing the initial allocation of resources and then letting people freely trade • Interference with market prices, which impairs efficiency, is unnecessary 3 -18
Efficiency versus Equity Eve Fig leaves per year r 0’ p 3 p 5 q Does society have to choose between p 3 & q? 0 Adam s Apples per year 3 -19
Utility Possibilities Curve Adam’s utility Maximum amount of one person’s utility given each level of another person’s utility U p 3 p 5 q U Eve’s utility 3 -20
Social Indifference Curve Adam’s utility Society’s willingness to trade off one person’s utility for another’s W = F(UAdam, UEve) Increasing social welfare Eve’s utility 3 -21
Adam’s utility Maximizing Social Welfare If society values a more equitable distribution of goods embodied in Social Indifference Curves, fairness and efficiency are possible (iii) i ii Eve’s utility 3 -22
Market Failures: Causes of Inefficiency • Market Power – Monopoly • Nonexistence of Markets – Asymmetric information – Externality – Public good 3 -23
Buying into Welfare Economics: The Controversies • Underlying outlook is individualistic – Merit goods: commodities that output to be provided even if people do not demand it. • Results orientation rather than the process used to arrive at the results • However, coherent framework for analyzing policy – Will it have desirable distributional consequences? – Will it enhance efficiency? – Can it be done at a reasonable cost? 3 -24
Chapter 3 Summary • Welfare economics is the study of the desirability of different economic states – Based on individualist social philosophy • Pareto efficiency occurs when no person can be made better off without making another person worse off – MRSixy = MRTxy i=persons i…. n • First Fundamental Theory of Welfare Economics: Competitive markets result in Pareto efficiency • Second Fundamental Theory of Welfare Economics: Society can attain any Pareto Efficient outcome with reassignment of initial endowments and free trade 3 -25
- Mcf3 framework
- Tools of normative analysis
- Tools of normative analysis
- Tools of normative analysis
- Normative statement
- Positive vs normative statement
- Objectives of welfare economics
- Conclusion of welfare economics
- Father of welfare economics
- Roefie hueting
- Maastricht university school of business and economics
- Elements of mathematical economics
- Ben sprung keyser
- Structured analysis tools
- Cutting tools in sewing with pictures and meaning
- Euac economics
- Replacement analysis
- Marginal analysis in economics
- Replacement analysis in engineering economics
- Demand estimation in managerial economics
- Demand and supply analysis in managerial economics
- Managerial economics demand analysis
- Replacement analysis in engineering economics
- évaluation formative sommative normative
- Wall toss test normative data
- Moral ethics examples