Presentation on theme: "General Equilibrium and Economic Welfare Perloff Chapter 10."— Presentation transcript:
General Equilibrium and Economic Welfare Perloff Chapter 10
General Equilibrium Partial equilibrium –Changes in equilibrium are analysed in one (or a few) markets in isolation. –Prices and quantities in unrelated markets are held fixed. General equilibrium –The study of how equilibrium is attained in all markets simultaneously.
GE in Corn and Soya Beans Soybeans, Billion bushels per year e 0 s e 2 s e 4 s D 4 s D 2 s S 4 s S 2 s S 0 s D 0 s $4.12 $ $ (b) Soybean Market Corn, Billion bushels per year e 0 c e 1 c e 3 c D 0 c D 1 c S 3 c S 0 c $2.15 $ $ (a) Corn Market Price, $ per bushel
Min. wages with incomplete coverage L, Annual hours (a) Covered Sector(b) Uncovered Sector(c) Total Labor Market w 1 w 1 w 1 w 2 w – S L c 2 L c 1 L u 2 L u 1 L c 1 L u 1 L 1 =+ D c D u S u D L c, Annual hoursL u w, Wage per hour
Trade Between People: The Edgeworth Box I 1 j I 1 d (a) Janes Endowment Janes candy Candy, Bars 0 j e j (b) Denises Endowment Denises candy Candy, Bars 0 d e d Firewood, Cords
Obtaining the contract curve Janes candy Denises candy g c d e b a f B Contract curve 0 j 0 d I 1 j I 2 j I 3 j I 4 j I 0 d I 1 d I 2 d I 3 d Janes wood Denises wood
Four equivalent statements about points on the contract curve The indifference curves are tangential. The marginal rates of substitution are equal. No further mutually beneficial trades are possible. The allocation is Pareto efficient: One person cannot be made better off without making the other worse off.
Price that doesnt lead to equilibrium 80 (b) Prices That Do Not Lead to a Competitive Equilibrium Janes candy Denises candy Price line e a j d j 0 d I 1 j I 2 j I 1 d I 2 d Denises wood Janes wood
Price that leads to equilibrium (a) Price Line That Leads to a Competitive Equilibrium Janes candy Denises candy Price line e a f j 0 d I 1 j I 2 j I 1 d I 2 d Janes wood Denises wood
The competitive equilibrium is Pareto efficient. Any efficient allocations can be achieved by competition. –Any point on the contract curve can be achieved by trade along the appropriate price line. –Achieving the desired point may involve some redistribution (value judgements required) Theorems of Welfare Economics
Production Possibilities I 1 I 2 PPF Candy, Bars a b Firewood, Cords
Competition Ensures Efficiency
The whole picture Price line PPF 1 80Candy, Bars 0 j 1 – 2 – Firewood, Cords 50 a
Is efficiency enough? Many policies make somebody better off at the expense of somebody else. Producer surplus plus consumer surplus. –As long as producers gain more than consumers lose, its efficient eg. first degree price discrimination. –Weights producers and consumers equally.
Welfare maximisation UPF c a b e (a) Janes utility W 1 W 2 W 3 (b) Janes utility W 1 W 2 W 3 Denises utility
How do we arrive at a social preference ranking Individuals rankings are transitive We need a rule which allows us to convert individual rankings into a social ranking. –Majority voting 2 prefer a to b, 2 prefer b to c, transitivity would require 2 to prefer a to c. But 2 prefer c to a.
Voting with non-transitive prefrences With non-transitive preferences result depends on order the vote is taken in. a compared to b then compare winner to c –a chosen in first vote –c chosen in second vote c compared to a then compare winner to b –c chosen in first vote –b chosen in second vote
Arrows impossibility theorem Desirable properties of a social preference ordering. –Complete –If everyone prefers a to b, the social ranking should do the same –Social ranking of a to b should not depend on the what other alternatives are available –Dictatorship is not allowed No rule exists which produces a ranking that always satisfies these properties