Revision Map - Topics 1-6 PDF

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Micro 2 – Revision MapsTOPIC 1ASSUMPTIONS: Economic acivity: consumpion and trading (no producion)  Each consumer is described completely by: o His preference (or uility funcion) o His iniial endowment of commodiies  No externaliies or public goods  Consumer preferences are monotonic  Compeiive...

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Micro 2 – Revision Maps TOPIC 1

ASSUMPTIONS:  Economic activity: consumption and trading (no production)  Each consumer is described completely by: o His preference (or utility function) o His initial endowment of commodities  No externalities or public goods  Consumer preferences are monotonic  Competitive behaviour  Rationality PARETO EFFICIENCY:  A feasible allocation x is Pareto efficient (PE) if there is no other feasible allocation x such that xi’>ixi for any i  That is, we can no longer make everyone better of  In other words, the allocation at a PE point cannot be improved upon, without harming someone else  PE can be proven by contradiction GENERAL EQUILIBRIUM:  The pair (p*, x*) is called the general equilibrium if: o For each i, x*i solves consumer I’s utility max problem o X* is feasible (markets clear D-S)

WALRAS’ LAW  The value of aggregate excess demand is identically zero, for all set of prices, not just in equilibrium IMPLICATION:  If (at some p>>0), m-1 markets clear, then the remaining market must also clear

WELFARE ECONOMICS:  Normative economics o Analysis of how things should be  Social welfare function formalizes the philosophy, the morality, and the norms behind the choices made by society SOCIAL WELFARE MAXIMISATION:  To achieve a social optimum, we have to max the social welfare function (SWF) given the resource is available in the economy PARETO OPTIMALITY & SOCIAL OPTIMUM:  Given the SWF, the allocation E* is chosen on the utility possibility frontier (UPF) such that achieves the highest level of isowelfare curve:  An allocation of resources is socially optimal, if it satisfies the following two conditions o Must be an efficient allocation o Must be an equitable allocation  Moral issue o Which social welfare function should we use?  Depends on what one thinks in terms of equity o Bentham suggests that we should max the sum of people’s utilities o We could generalize the Benthamin SWF and give diferent people diferent weights

o Rawls suggested that we should seek to max the utility of the least well or in society FTWE:  Every Walrasian equilibrium is Pareto Efficient CONDITIONS:  Monotonic preferences  Competitive behaviour (no market power; monopoly)  Rationality (individuals max their utility – choices are consistent)  No market imperfections such as externalities and public goods  Complete information  The market is efficient  The outcome is depended to the initial endowment STWE:  Every PE allocation can be decentralised as a Walrasian Equilibrium CONDITIONS:  Convex preferences o If the preferences of both consumers are convex, then the common tangent will not intersect either indiference curve more than once. o If we have no convex preferences, as a result an equilibrium price does not exist no matter where the endowment point is. We cannot find a straight line that separates the two indiference curves. o The proof is essentially a geometric argument. Summarizing, the STWE says that when preferences are convex, a PE allocation can be achieved as an equilibrium for some set of prices  Monotonic preferences  Competitive behaviour (no market power; monopoly)  Rationality (individuals max their utility – choices are consistent)  No market imperfections like externalities and public goods  Complete information IMPLICATIONS:  The issue of efficiency and the issue of equality distribution are two distinct issues  The market mechanism is distributional neutral o The price plays two diferent roles in the market system: an allocative and a distributive role  The positive role of the social planner (government): o The distributional issues should be resolved by changing the initial endowments (lump-sum transfer) and not by changing the competitive pricing mechanism

TOPIC 2A/B EXTERNALITY:  Emerges whenever the well-being of an agent is directly afected by the actions of another agent in the economy o Externalities describe efects from one agent to another that are not captured by the price systems o When they are present, the market fails to produce the optimal amount of the good CONSUMPTION EXTERNALITY:  Consumption externality emerges whenever the well-being of a consumer (or the utility) is directly afected by the actions of another agent in the economy

PRODUCTION EXTERNALITY:  Production externalities can arise between firms when the profit of one firm is afected by the action of another agent that imposes an external cost

COMMON PROPERTY RESOURCES:  The central question about the common’s dilemma is to explain the inefficient management of natural resources (lakes, oceans, lands, etc…)

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It is important to make a distinction between resources held as common property and those subject to open access o Common property involves a well-defined community of users who are able in practice, if not under the law, to prevent outsiders from exploiting the resources: inshore fisheries, grazing lands or forest areas are examples o Open access resources can be exploited without restrictions, other than those imposed by states: ocean fisheries or the atmosphere as a carbon sink as examples

POSSIBLE SOLUTIONS:  Per unit tax  Quotas/Permits  Regulation: well-defined property rights

TOPIC 2C PUBLIC GOOD:  A public good has two characteristics o Non-rival: consumption of the public good by one consumer does not reduce the quantity available for consumption for others o Non-excludable: if the public good is supplied, no consumer can be excluded from consuming it

FREE RIDER PROBLEM:

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With a private provision of a public good, we have the following problems o Private information: the contribution of each one is a private information. Each consumer i decides their contribution gi, privately and has no influence over the other individual’s contribution decision o The public good is non-excludable - there is no way to exclude anyone from enjoying it o Conflict of interest between collective interest and private interest The public good is likely to be under provided compared to the social optimum...