EFFICIENCY AND EQUITY

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EFFICIENCY AND EQUITY
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What is Efficiency?

• No waste
• Maximization of societys net benefits
• Pareto Efficiency

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Maximization of Net Benefits

Marginal Social Cost
Deadweight Loss
Marginal Social Benefit
0
Q1
Qopt
Output
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Pareto Efficiency

• The definition
• Edgeworth Box
• Pareto efficicient versus Pareto superior
• The contract curve
• Movements along the contract curve
• Partial ranking of alternatives

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Edgeworth Box
Clothes
0B
B1
B2
B3
X
B4
Food
Food
Y
Z
A5
H
A4
G
A3
A2
A1
0A
Clothes
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The Two Fundamental Theorems of Welfare Economics

• The perfectly competitive equilibrium is
  efficient.
• Any efficient outcome can be achieved as a
  competitive equilibrium.

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The First Fundamental Theorem
MRSFC PC/PF. Everyone faces same
prices. Therefore MRS same for everyone. Therefore
efficient.
Food
0
Clothes
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How Realistic Is the First Theorem?

• Market failure
• externalities
• public goods
• Imperfect information
• Natural monopoly

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The Second Fundamental Theorem
Clothes
0B
B1
B2
B3
B4
Food
Food
A4
A3
A2
A1
0A
Clothes
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How Realistic Is the Second Theorem?

• The difficulty of lump-sum redistribution
• How do we know what distribution is best?

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Social Welfare Functions

• Expression of societys welfare as determined by
  individual utilities

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The Benthamite SWF

• W U1 U2 U3

Bliss
U1
0
W1
W2
W3
W4
U2
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The Rawlsian SWF

• W minU1, U2, U3,

U1 U2
W3
Bliss
U1
W2
W1
45o
0
U2
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General SWF

• W f(U1, U2, U3, )

Bliss
U1
W4
W3
W2
W1
0
U2