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Warning
• Much of what follows if not in the course textbook
• Some of it comes from the far more advances Mas-Collel, Whinston & Green textbook
• Some of it comes from too many dispersed sources
• So come to class!
Goals
• Want to make normative statements• First, without any cardinality assumptions
– Pareto efficiency– Welfare theorems
• Next, with cardinality assumptions– Consumer surplus
– Social welfare functions– Social choice functions
Basic question
• In GE framework– Allocation:
• Consumption/production vector
– Feasible allocation
• How do we compare feasible allocations?– Which one do we pick?
No interpersonal comparisons
• Originally, utility fn only ordinal– Building blocks
• Implications for interpersonal comparisons– Are tradeoffs possible?
Pareto efficiency
• Can still eliminate subset of feasible allocations
• Definition of Pareto efficient allocation
Pareto superiority
• Definition of superiority
• Pareto efficiency does not imply superiority
– Major stumbling block for potential policies• E.g., lobbying
Other problems
• Information requirements
• Still doesn’t yield unique prescription
• Silent on distribution
• So need something else
Competitive markets
• Despite problems, still desirable property
• However given info problems, how to implement it?
FFTWE
• Statement
• Assumptions– Price-taking
– Perfect information– No externalities/complete markets
FFTWE – sketch proof
• Consumers– Relative prices = MRS
• = desirability of switching
• Producers– Relative prices = TRS
• = ability to switch
• Breakdowns
FFTWE
• Implication– Can trust market
• However– Equity?– Doesn’t always Pareto dominate alternative
• Also– Assumptions
Need interpersonal comparisons
• Even under ideal conditions, FFTWE is silent on distribution– Need refinement
• Social welfare fn– Definition
• Domain
• Range
Social welfare fns
• Under ordinal utility, extent of preference did not exist
• For non-degenerate social welfare fn to exist
– need cardinal utility
First-best planner problem
• Statement
• Q: how does Pareto efficiency relate to the solution?
– Which properties define link?
Standard procedure in micro
• Previously (positive economics)1. Make assumptions
• Action space• Payoff functions
2. Solve for behaviour3. Derive testable predictions4. Empirically evaluate model
• Now add one step (normative economics)– Solve planner problem
• Check if system is efficient• Make prescriptions
Problems with social choice theory
• Arrow critique– Impossibility theorem
• Sen critique– Questions Pareto efficiency
• Operationalisability critique
Application: cost-benefit analysis
• Easiest social welfare fn is pure utilitarian
• Need to cardinalise utility– Q: what’s the easiest unit?
Monetising utility
• How to get from utility to money?• Easiest way
– Have a base and an alternative allocation• Typically status quo and potential policy alternative
– E.g., a price change
Recap on CS and PS
• CS and PS allows us to measure welfare effects of price changes– Allow interpersonal comparison
• Also allow winner/loser breakdown