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yagnesh-sondarva
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Welfare economics
• The branch of economics dealing with
normative issues.
• Its purpose is not to describe how the
economy works
• but to assess how well it works.
Equity and efficiency
• Horizontal equity
– the identical treatment of identical people
• Vertical equity
– the different treatment of different people in
order to reduce the consequences of their
innate differences
Pareto efficiency
• An allocation is Pareto-efficient for a given set
of consumer tastes, resources and technology,if it is impossible to move to anotherallocation which would make some peoplebetter off and nobody worse off.
Perfect competition and Pareto efficiency
• If every market in the economy is a perfectly
competitive free market, the resultingequilibrium throughout the economy will bePareto-efficient.
• As expressed in Adam Smith’s notion of the
Invisible Hand.
Distortions
• A distortion exists whenever society’s marginalcost of producing a good does not equal society’smarginal benefit from consuming that good.
– some such distortions may be inevitable
– and it may be more efficient to spread such
distortion over a wide range of markets, rather
than concentrating it in one market
– this results from the theory of the second-best
Market failure
• …occurs when equilibrium in free unregulated markets will fail to achieve an efficient allocation.
• Imperfect competition
• Social priorities (e.g. equity)
• Externalities
• Other missing markets
• – future goods, risk, information
Externalities
• externality arises whenever an individual’s
production or consumption decision directly
affects the production or consumption of others
…
• other than through market prices
– e.g. a chemical firm discharges waste into a lake & ruins the fishing for anglers