Presentation on theme: "General Equilibrium and Economic Welfare"— Presentation transcript:
1 General Equilibrium and Economic Welfare Perloff Chapter 10
2 General Equilibrium Partial equilibrium General equilibrium Changes in equilibrium are analysed in one (or a few) markets in isolation.Prices and quantities in ‘unrelated’ markets are held fixed.General equilibriumThe study of how equilibrium is attained in all markets simultaneously.
3 GE in Corn and Soya Beans (a) Corn MarketScSc3ecPrice, $ per bushel$2.15Dcec$1.91711ec3$1.9057Dc18.2278.26138.44Corn, Billion bushels per year(b) Soybean MarketSses$4.12Price, $ per bushelDsSs2Ss4es2$3.8325$3.8180es4Ds2Ds42.05052.05142.07Soybeans, Billion bushels per year
4 Min. wages with incomplete coverage (a) Covered Sector(b) Uncovered Sector(c) Total Labor Marketw, Wage per hourw, Wage per hourw, Wage per hourSw–Suwww111Demand curve is the sum of individual demands in the two sectors.Interaction of S and D at aggregate level produces a wage of w1 and corresponding levels of employment in the 2 sectors.Min wage in in the covered sector causes employment to fall. Supply in the uncovered sector is effectively increased. Supply can be found as Market supply minus employment in the covered sector. This gives a new eq at w2.w2DcDuDL2L1L1L2L=L1+L1ccuu1cuL, Annual hoursL, Annual hoursL, Annual hourscu
7 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.
8 Price that doesn’t lead to equilibrium (b) Prices That Do Not Lead to a Competitive EquilibriumDenise’s candy806043d5045Denise’s woodI1de3020I2dj22d32I2j1.5 logs exchanged for 2 candy. Auctioneer recognises the existence of excess supply and demand and doesn’t allow trade. Calls out a new set of pricesI1jJane’s woodPrice linea50j20306080Jane’s candy
9 Price that leads to equilibrium (a) Price Line That Leads to a Competitive EquilibriumDenise’s candy806040d50Denise’s wood40I1de3020I2df2030I2jI11 log is exchanged for 2 candy.jJane’s woodPrice linea50204080jJane’s candy
10 Theorems of Welfare Economics 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)
11 Production Possibilities 2Firewood, CordsI1PPFa50Condition for efficient product mix.b80Candy, Bars
13 The whole picture Price line Firewood, Cords 1 – – 2 1 PPF Jane s candyJane’s wood40IjdPrice line1–22030fDenise’Denise’s wooda50j80Candy, Bars’
14 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.
16 Welfare maximisation (a) (b) a Denise’s utility Denise’s utility UPF 3The right hand picture shows the situation where we individuals welfare are weighted equally regardless of how much they have. Argue that the left is more realistic.W1W2cW1W2W3Jane’s utilityJane’s utility
17 How do we arrive at a social preference ranking Individuals rankings are transitiveWe need a rule which allows us to convert individual rankings into a social ranking.Majority voting2 prefer a to b, 2 prefer b to c, transitivity would require 2 to prefer a to c.But 2 prefer c to a.
18 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 ca chosen in first votec chosen in second votec compared to a then compare winner to bc chosen in first voteb chosen in second vote
19 Arrow’s impossibility theorem Desirable properties of a social preference ordering.CompleteIf everyone prefers a to b, the social ranking should do the sameSocial ranking of a to b should not depend on the what other alternatives are availableDictatorship is not allowedNo rule exists which produces a ranking that always satisfies these properties