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CHAPTER 3 Tools of Normative Analysis Copyright © 2010 by the McGraw-Hill Companies, Inc. All...
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Transcript of CHAPTER 3 Tools of Normative Analysis Copyright © 2010 by the McGraw-Hill Companies, Inc. All...
CHAPTER 3
Tools of Normative Analysis
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
3-2
Welfare Economics
• Welfare Economics – branch of economic theory concerned with the social desirability of alternative economic states
3-4
Indifference curves in Edgeworth Box
Adam
Eve
0
0’
s
r
Apples per year
Fig
leav
es p
er y
ear
A1
A2
A3
E1
E3
E2
3-5
Making Adam better off without Eve becoming worse off
Adam
Eve
0
0’
s
r
Apples per year
Fig
leav
es p
er y
ear
Ag
Ah
Ap
Eg
gh
p
A Pareto Efficient
Allocation
3-6
Making Eve better off without Adam becoming worse off
Adam
Eve
0
0’
s
r
Apples per year
Fig
leav
es p
er y
ear
Ag
Egg
p1
pEp1
A Pareto Efficient
Allocation
3-7
Making both Adam and Eve better off
Adam
Eve
0
0’
s
r
Apples per year
Fig
leav
es p
er y
ear
Ag
Eg
g
p1
p
Ep2
Ap2
p2
• Pareto efficient
• Pareto improvement
3-8
Starting from a different initial point
Adam
Eve
0
0’
s
r
Apples per year
Fig
leav
es p
er y
ear
Ag
Eg
g
p1
p
Ep2
Ap2
p2
p3
p4
k
3-9
The Contract Curve
Adam
Eve
0
0’
s
r
Apples per year
Fig
leav
es p
er y
ear
Ag
Eg
g
p1
p
Ep2
Ap2
p2
p3
p4
The contract curve
3-11
Production Possibilities Curve
Apples per year
Fig
leav
es p
er y
ear
C
C0
w
y
x z
│Slope│ = marginal rate oftransformation
3-12
Marginal Rate of Transformation
• MRTaf = Marginal rate of transformation of apples for fig leaves
• MRTaf = MCa/MCf
3-13
Efficiency Conditions with Variable Production
• MRTaf = MRSaf = MRSaf
• MCa/MCf = MRSaf = MRSaf
Adam Eve
Adam Eve
3-14
The First Fundamental Theorem of Welfare Economics
• MRSaf = Pa/Pf
• MRSaf = Pa/Pf
• MRSaf = MRSaf
• MCa/MCf = Pa/Pf
• MRTaf = Pa/Pf
• Pa/Pf = MCa/MCf
Adam
Eve
Adam Eve
3-17
Social Indifference Curve
Eve’s utility
Ada
m’s
util
ity
W = F(UAdam, UEve)
Increasingsocialwelfare
3-19
Market Failure
• Market Power– Monopoly
• Nonexistence of Markets– Asymmetric information– Externality– Public good