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Flashcards in General Equilibrium and Welfare Deck (22)
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1
Q

What is the definition of Partial Equilibrium analysis?

A

When analysis is focused on a single market -> ignores the idea that markets are interrelated and that spillovers between markets may exist

2
Q

What is General Equilibrium analysis?

A

Analysis that views the economy as a system of related markets -> it endogenises prices and incomes

3
Q

Partial vs General: which analysis is better?

A

General is a lot more effective in analysing the impacts of policies or changes in other markets on the economy as a whole. Partial analysis only analyses the effects on the localised market

4
Q

What are the conditions of pure exchange?

A

There are 2 people, 2 goods and no production -> only exchange

5
Q

How does pure exchange work?

A

Consumers have an initial endowment of goods and will try to maximise their utility

6
Q

What is the name of the diagram where the 2 IC’s in pure exchange are combined?

A

The Edgeworth Box

7
Q

What is the shape of the IC’s in the Edgeworth box?

A

One set of axis is flipped and where the ICs of the 2 consumers cross at their bundles, this will be the endowment point

8
Q

What does the lens area in an Edgeworth box represent?

A

It represents the area where trade can occur for both parties to increase utility -> the more trade occurs the smaller the lens area gets

9
Q

What does Pareto Optimality look like in the Edgeworth box?

A

The two ICs will have shifted until they have achieved tangency and their MRS’s are equal -> there will be no lens area left

10
Q

What is the definition of Pareto Optimality?

A

The point at which no party can increase their utility without the utility of the other party being diminished

11
Q

Can there be more than 1 Pareto Efficient point? If yes, where do they lie?

A

Yes there can be several Pareto Optimal points and they all lie on the Contract Curve

12
Q

What is a competitive equilibrium?

A

A condition where profit-maximising and utility-maximising consumers in a freely competitive market with freely determined prices reach an equilibrium price

13
Q

What does the First Welfare Theorem state?

A

That a competitive equilibrium can become a Pareto efficient one -> everyone is as well off as they can be

14
Q

What assumption is made in the first welfare theorem about market imperfections?

A

That they do not exist -> externalities, monopolies or public goods are assumed to not exist

15
Q

How is the First Welfare Theorem achieved?

A

Through trade, where consumers trade to reach efficiency

16
Q

What does the Second Welfare Theorem state?

A

That any efficient equilibrium can be converted into an efficient equilibrium

17
Q

How is the Second Welfare Theorem achieved?

A

The government will redistribute the initial endowments to a point where there are in line with Pareto Efficiency

18
Q

What must not happen during the redistribution in the Second Welfare Theorem for it to hold?

A

It cannot shrink the economy

19
Q

How is it very difficult not to shrink an economy when redistributing endowments?

A

The government will use things like taxes and subsidies to redistribute goods, which often lead to deadweight losses -> which shrink the economy

20
Q

For a diagram and the Second Welfare Theorem:

A

Check notes

21
Q

What must the preferences of both parties be for the Second Welfare Theorem to stand?

A

Both parties must have convex preferences where the budget curve only touches the IC once

22
Q

What would happen if preferences are not convex?

A

The Second Welfare Theorem may not hold because although there may be Pareto Efficiency, this point may not be at a price level where both parties want to consume