General Equilibrium & Welfare

What is general equilibrium analysis?

It examines how price and output are determined in multiple markets simultaneously.

What is Pareto Optimality?

An allocation of goods is Pareto Optimal when no redistribution can make one individual better off without making another worse off.

What are the characteristics of a competitive equilibrium that is Pareto optimal according to the first theorem of welfare economics?

1. Price taker behavior (perfect competition); 2. Non-satiation of preferences; 3. No externalities; 4. Perfect information.

What is the difference between Pareto efficiency and desirability?

Pareto efficiency indicates that no one can be made better off without making someone worse off, but it does not imply that the outcome is desirable.

What is exchange efficiency?

It occurs when two individuals can trade goods to make both better off, achieving a Pareto improvement.

What is the Marginal Rate of Substitution (MRS)?

The rate at which a consumer is willing to give up one good for another while maintaining the same level of utility.

How do indifference curves relate to Pareto optimality?

At the point of tangency between two indifference curves, the MRS of both individuals is equal, indicating Pareto optimality.

What is the contract curve?

A line showing all allocatively efficient bundles where the MRS are equal.

What happens when government reallocates resources?

It can harm one party but may lead to an efficient outcome through exchange afterward.

What is the effect of a lump-sum reallocation on market efficiency?

It does not directly influence price in a specific market, maintaining efficiency.

What is the second welfare theorem?

A group can be made better off without losing efficiency

What is a Pareto improvement?

A change that makes at least one individual better off without making anyone worse off.

What does it mean if two households are on different indifference curves?

One household is better off than the other, indicating potential for Pareto improvement through exchange.

How does a progressive tax system affect market efficiency?

It can shift outcomes to a new point on the contract curve without affecting efficiency.

What is the significance of the Edgeworth Box in welfare economics?

It illustrates the efficiency and Pareto optimal outcomes through the exchange of goods.

What is the relationship between total surplus and efficiency?

Total surplus maximized indicates efficiency and is synonymous with Pareto optimality.

What does the term 'non-satiation of preferences' imply?

Consumers prefer more of a good to less, indicating that they will always seek to maximize their utility.

What is the effect of externalities on market efficiency?

Externalities can prevent markets from achieving Pareto optimal outcomes.