Welfare economics. Lecture note 5

Transcription

1 Welfare economics Lecture note 5

2 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!

3 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

4 Basic question In GE framework Allocation: Consumption/production vector Feasible allocation How do we compare feasible allocations? Which one do we pick?

5 Edgeworth box and utility possibility frontier

6 No interpersonal comparisons Originally, utility fn only ordinal Building blocks Implications for interpersonal comparisons Are tradeoffs possible?

7 Pareto efficiency Can still eliminate subset of feasible allocations Definition of Pareto efficient allocation

8 Diagram on UPF

9 Diagram on Edgeworth box

10 Pareto superiority Definition of superiority Pareto efficiency does not imply superiority Major stumbling block for potential policies E.g., lobbying

11 Other problems Information requirements Still doesn t yield unique prescription Silent on distribution So need something else

12 Competitive markets Despite problems, still desirable property However given info problems, how to implement it?

13 FFTWE Statement Assumptions Price-taking Perfect information No externalities/complete markets

14 FFTWE sketch proof Consumers Relative prices = MRS = desirability of switching Producers Relative prices = TRS = ability to switch Breakdowns

15 FFTWE diagram Edgeworth box Note previous diagram Exchange economy: MRS equalised

16 FFTWE Implication Can trust market However Equity? Doesn t always Pareto dominate alternative Also Assumptions

17 Need interpersonal comparisons Even under ideal conditions, FFTWE is silent on distribution Need refinement Social welfare fn Definition Domain Range

18 Social welfare fns Under ordinal utility, extent of preference did not exist For non-degenerate social welfare fn to exist need cardinal utility

19 Social welfare fns Examples Rawlsian Convex Utilitarian Equal weights Different weights

20 Social welfare fns Typical features Increasing Symmetric Convex

21 First-best planner problem Statement Q: how does Pareto efficiency relate to the solution? Which properties define link?

22 Standard procedure in micro Previously (positive economics) 1. Make assumptions Action space Payoff functions 2. Solve for behaviour 3. Derive testable predictions 4. Empirically evaluate model Now add one step (normative economics) Solve planner problem Check if system is efficient Make prescriptions

23 Problems with social choice theory Arrow critique Impossibility theorem Sen critique Questions Pareto efficiency Operationalisability critique

24 Application: cost-benefit analysis Easiest social welfare fn is pure utilitarian Need to cardinalise utility Q: what s the easiest unit?

25 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

26 CV & EV Compensating variation Equivalent variation

27 CV diagram

28 EV diagram

29 CV vs. EV Cause of difference Which is preferred?

30 Measurement Direct survey Revealed preference method Q: pros and cons?

31 Consumer surplus One alternative is consumer surplus Definition Intuition on definition

32 Consumer surplus diagram

33 CS vs EV vs CV How are they related When are they all the same

34 Why use CS? Main advantage is potential additional method of quantification

35 Producers surplus Definition: Intuition: Less complicated than CS because:

36 PS diagram

37 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

38 Example: imposing a tax

39 Example: price ceiling