1. Lectures in Microeconomics-Charles W. Upton More Welfare Economics

2. Some Basic Assumptions A simple economy:Harry and Sally. There are two factors of production, capital, K, and labor, L. L = L H + L S These two factors of production can be used to produce either apples or bananas.

3. More Welfare Economics Three Basic Questions 1.How many apples and how many bananas should be produced? 2.How should the apples and bananas be allocated between Harry and Sally? 3.How should capital and labor be allocated to the production of apples and bananas?

4. More Welfare Economics What We Have Seen Markets get us Pareto Optimality in Distribution. MRS(Harry) = MRS (Sally) There is more to the story.

5. More Welfare Economics Pareto Optimality in Production Apples BananasLabor Capital A B

6. More Welfare Economics Pareto Optimality in Production Apples BananasLabor Capital A B The Production Frontier

7. More Welfare Economics Pareto Optimality in Production Apples BananasLabor Capital A B The Production Frontier MRTS A KL = MRTS B KL

8. More Welfare Economics Integration Bananas Apples Production Possibility Frontier

9. More Welfare Economics Integration Bananas Apples Production Possibility Frontier

10. More Welfare Economics Integration Bananas Apples Production Possibility Frontier Slope = MRT

11. More Welfare Economics Integration Bananas Apples Production Possibility Frontier Slope = MRT Harry and Sally’s Contract Curve and Indifference Curves

12. More Welfare Economics Integration Bananas Apples Production Possibility Frontier Slope = MRT Harry and Sally’s Contract Curve and Indifference Curves Slope = MRS

13. More Welfare Economics Integration Bananas Apples The ownership of capital determines where we end up.

14. More Welfare Economics Integration Bananas Apples The ownership of capital determines where we end up. MRS = MRT

15. More Welfare Economics Integration Bananas Apples The ownership of capital determines where we end up. MRS = MRT We are Pareto Optimal

16. More Welfare Economics Integration Bananas Apples The ownership of capital determines where we end up. MRS = MRT We are Pareto Optimal But we can change the initial endowment

17. More Welfare Economics Summing Up This is the basic proof of the efficiency of the free market.

18. More Welfare Economics Summing Up This is the basic proof of the efficiency of the free market. MRS = MRT. We are Pareto Optimal..

19. More Welfare Economics Summing Up This is the basic proof of the efficiency of the free market. The primary objection people raise is about the resulting distribution of income.

20. More Welfare Economics Income Distribution The primary objection people raise is about the resulting distribution of income.

21. More Welfare Economics Income Distribution The primary objection people raise is about the resulting distribution of income. How can the market be so good if a very wealthy person can feed his dogs filet minion while others are struggling to live on dog food?

22. More Welfare Economics Income Distribution The primary objection people raise is about the resulting distribution of income. How can the market be so good if a very wealthy person can feed his dogs filet minion while others are struggling to live on dog food? All we have shown is that the competitive solution achieves efficiency.

23. More Welfare Economics Income Distribution The primary objection people raise is about the resulting distribution of income. How can the market be so good if a very wealthy person can feed his dogs filet minion while others are struggling to live on dog food? All we have shown is that the competitive solution achieves efficiency. We cannot make one person better off without making another worse off

24. More Welfare Economics Income Distribution The primary objection people raise is about the resulting distribution of income. How can the market be so good if a very wealthy person can feed his dogs filet minion while others are struggling to live on dog food? All we have shown is that the competitive solution achieves efficiency. We cannot make one person better off without making another worse off If we take filet from the wealthy, depriving their dogs, to give to the poor, we are making one person better off and another worse off

25. More Welfare Economics Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor.

26. More Welfare Economics Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. –If you think Harry is getting too much at the expense of Sally, economists argue you ought to redistribute income by redistributing the ownership of capital from Harry to Sally.

27. More Welfare Economics Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. Efforts to interfere with markets lead to inefficiency. We end up inside the production possibility curve.

28. More Welfare Economics Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. Efforts to interfere with markets lead to inefficiency. We end up inside the production possibility curve. –Most distribution schemes involve income taxes –If I must pay a tax of (say) 50% of my salary, then my incentives to work are reduced.

29. More Welfare Economics End ©2006 Charles W. Upton