Theorem Of Welfare Economics

Submitted By 瑜洁-黄
Words: 1178
Pages: 5
Open Document
State the two fundamental theorems of welfare economics and briefly explain why they hold.

Pareto efficiency
An allocation in an economy is Pareto efficient(sometimes called Pareto optimal) if it is impossible to reallocate resources to make someone better off without making someone else worse off.

The set of Pareto efficient allocations is given by the line between 0a and 0b. It is called the contract curve.

Subject to certain conditions (see later) we have the following two theorems:

First Theorem of Welfare Economics:
All competitive market equilibria are Pareto efficient.
Second Theorem of Welfare Economics:
Every Pareto efficient allocation is a competitive equilibrium (under certain conditions including the ability to make non-distortionary transfers).

The first theorem of welfare economics depends on several special circumstances. These include:
 There must be no externalities, e.g., pollution. This point includes the fact that consumers must not care about others consumption levels. This is a complex issue since if consumers do not care about the welfare of others then why do we vote for redistributive taxes?
 There must be no public goods.
 Consumers must behave competitively, there must be no monopoly power.
 There must be no asymmetric information.

The First Theorem of Welfare Economics ‘suggests’ that markets and competition is ‘good’ for society. This theorem is a formal statement of a view that has had a big influence over the years on political debate. The point that markets require little information (which I made earlier in the lecture) is to some extent a separate point but leads to similar conclusions. But is Pareto efficiency something that is desirable? How does one choose between two alternative distributions of society’s wealth?

The Second Theorem of Welfare Economics implies that efficiency and distribution can be separated. It suggests that governments, if they are purely concerned about individual welfare, should try not to intervene on prices, i.e., should not be paternalist. Instead they should redistribute endowments and let the market then decide what is purchased. The tax example, in the previous subsection, part (iii), is an example of the problems that arise when governments do not do this.

Explain the terms moral hazard and adverse selection

 Adverse selection (sometimes called a hidden information problem)
One of the parties has superior information about some exogenous variable before engaging in a contractual agreement
 Moral hazard (sometimes called a hidden action problem)
One of the parties takes some action that is unobserved by the principle

A numerical example of adverse selection - efficiency wages
Worker Productivity Supply Proportion type 1 1  0 if w≥1 ½ = 0 if w1 2 2  0 if w≥1.25 ½ = 0 if w1.25
Firms: need to produce 300; cannot identify type of workers.
(i) Suppose all firms offer w 1.25
Firm employs 200 workers
E(Output) 1002 1001 300 The total cost is 2001.25  250
(ii) Consider w 1 Firm employs 300 workers Output  3001 300
The total cost is 3001 300
The central point is that (i) cheaper then (ii) so firms prefer (i) even though the wage is lower in (ii) and there is excess supply of workers at the higher wage.

A numerical example of credit rationing
Two projects:
Project 1 30 with probability 0.33 15 with probability 0.33 0 with probability 0.33
Project 2 40 with probability 0.2 0 with probability 0.8
Project 1 better then project 2 since less risky and E(1) 15
Whereas E(2)  8.

Information:
Lenders do not know which project is undertaken.
Firm owners know which project is undertaken.

Case A: Money is given for project and repayment set at 14
Owners expected return is:
Owners expected return will depend on which project is
undertaken.
Show More

Related Documents: Theorem Of Welfare Economics

Global Reporting Guidelines (G2) Guideline

describe accounting for economic, social and environmental impacts, like triple bottom-line or corporate responsibility reporting. In 2001, GRI established the Measurement Working Group to develop recommendations on performance indicators…

Words 747 - Pages 3

Articles Of Confederation Essay

government – though it was essential to the creation of the Constitution – that simply did not resolve the economic issues being faced post-Revolution. Two challenges the nations faced under the Articles were the inability of Congress to levy taxes as well as the lack of power to regulate commerce. These two challenges eventually impeded economic growth and did little to resolve the economic issues the United States faced. The inability to levy taxes prevented the government from raising revenue…

Words 676 - Pages 3

Qmigdpupdatenoticefinalforpub Tcm77 180 Essay example

the contents, and updates to reflect the move to European System of Accounts 2010. Executive summary Gross domestic product (GDP) is arguably the most important aggregate or summary indicator for the purposes of economic analysis and comparisons over time. It measures total domestic economic activity and can be estimated in three different ways: the production approach; the expenditure approach and the income approach. Data are available on an annual basis back to 1948 and on a quarterly basis, for…

Words 5244 - Pages 21

Brandt Line Assessment Final Essay

The "Brandt Line", created by Willy Brandt in the 1980s, is a visual representation of developing and developed countries in the north and south side of the world. Since the original Brandt line just represents the economy of a state, this essay’s objective will be to recreate a new Brandt line, with updated data, using other two different developing indicators.1 For this reason, the new self-made Brandt line will show the current situation of the northern and southern art of the world by using…

Words 1099 - Pages 5

MODERN HISTORY SYLLABUS FOR REVISION PURPOSES Essays

MODERN HISTORY SYLLABUS FOR REVISION PURPOSES Active Revision (Don’t just read) Preferred Learning Styles Test yourself (See what you know): Syllabus / Past Paper Questions Make sure of the general (Know the ‘big picture’) Build on the specific (examples to support – quotes – historians) Plan of Attack (Order of questions/ timing) Use the dot points of the Syllabus to prompt your revision: Start with the points you think you remember the least about. Brainstorm as many factual details as you can…

Words 995 - Pages 4

Rbd Recycling Report Essay

1.0 - Introduction 2.0 - What is recycling and what is the reason for it 3.0 - Household waste 4.0 - Commercial and industrial recycling 5.0 - London result by WPA table 6.0 - revision and Error 7.0 -Types of revision * Schedule revision * Non-schedule revision 8.0 - References 1-Introduction The purpose of this report is too investigate figures for recycling in different regions of UK and discusses any increase or decreased for each of the figures…

Words 1447 - Pages 6

American Democracy In Colonial America

foundation for the well rounded American Democracy we have today. The House of Burgesses has democracy implemented into it because when the colonization of America began, King James the first created the Great Charter, followed by that revisions were made. These revisions led to a self- government which led colonists select representatives to govern an assembly. This assembly was called the House of Burgesses. It was self-governed which meant by people for people. This is important because…

Words 369 - Pages 2

W. E. B. Du Bois

ideologies of Karl Marx, stressed that socio-economic turmoil was caused by class: and in which class conflict would be the driving force for social change, which would be beneficial and Similar to the ideologies of BLM, they believe that society targets African Americans based on the division of socio-economic status, reiterating a revision necessary to establish equal opportunities for all, and to amplify a respect among the cultures of others, for the purpose of avoiding social inequality…

Words 237 - Pages 1

Roberto Unger Acceleration Theory Summary

re-formulation of constitutional politics in Democracy Realized are reactions to the increased speed of the present. Acceleration, in the form of recombinant innovations and unanticipated cross-applications of technology, characterizes contemporary economics. The economic world is moving quicker than it ever has. Capitalism is the primary imperative for this acceleration. Reducing turnover time increases profit, and discovering a new innovation before competitors do can bring enormous profits. Speed’s shrinkage…

Words 955 - Pages 4

Analysis of Wilfred Owen Essay

Economics Revision Sheet Inflation Economic Objectives Conflict of Objectives Unemployment Role of Government Inflation/ Unemployment Trade off Explain the trade cycle Trade/Business/Economic Cycle Over a given period of time (5-8yrs) the level of economic activity will tend to fluctuate The trade or business cycle is a pattern of expansion (recovery) and contraction (recession) Zone of desired economic activity or…

Words 398 - Pages 2