What is meant by the distinction between assessing a change in an individual’s
welfare versus assessing a change in social welfare?
Assessing a change in social welfare means aggregating the changes in welfare
across the individuals in society.
What is the “adding up” issue in assessing social welfare?
It is the issue of making an overall assessment of a policy or an action with regard
to whether it is good or bad, given that it affects different individuals, or different
groups, differently.
What is meant by an “interpersonal comparison of utility.”? Give an example
where assessing a policy or an action calls for an interpersonal comparison of
utility.
It is comparing the utility –or more often the change in utility – experienced by
one person versus that experienced by another person. One example is the
proposal to raise the minimum wage
Could there be some cases where an interpersonal comparison of utility is not
needed in order assess a policy or an action?
If everybody wins and there are no losers, or if everybody loses and there are no
winners, the assessment may be straightforward with no requirement for an
interpersonal comparison of utility.
Was Pareto in favor of making interpersonal comparisons of utility?
Yes
When it is required, is an interpersonal comparison of utility inherently a
subjective judgment or a value judgment?
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ASSIGNMENT
MARKET ALLOCATIONS AND WELFARE
Comparing separate individuals or groups whose wellbeing is affected differently
so as to form an overall judgment of what is best – what is in the public interest –
is inherently subjective and inherently a value judgment.
What is the conceptual difference between a pure exchange economy and an
economy with production and exchange?
a pure exchange economy is an artificial notion of an economy where
commodities exist but without production
an economy with production and exchange is a regular economy where the
commodities consumed by people are produced rather than being provided.
What is a Pareto-improving change?
Is one where nobody is left worse and one or more parties is made better off.
If, starting out from a given allocation of resources, it is possible to identify one or
more Pareto-improving changes, what does that tell you about the original
allocation? What term is applied in this case?
It tells us that the original allocation wasn’t great. It tells us that the original
allocation was not pareto efficient.
If, starting out from a given allocation of resources, there is no Pareto-improving
change that can be made, what does that tell you about the original allocation?
What term is applied in this case?
It tells us that the original allocation was pretty good, an allocation is said to be
paerto efficient if there is no feasible pareto improving change that can be made
to it.
How does Pareto efficiency in an allocation account for the fairness of that
allocation?
It doesnt
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If there are two allocations of resources that are each Pareto inefficient, how can
you rank them with the Pareto criterion?
If while both allocations are Pareto inefficient, switching from one allocation to
the other is a Pareto-improving change, then you can recommend the switch
occur. If not, then not.
If an economic institution – such as a competitive market -- is said to be Pareto
efficient, what does that mean?
It means that the institution generates economic outcomes that are Pareto
efficient.
Is voluntary exchange – barter, or participation in a competitive market – likely or
not to result in an allocation of resources that is Pareto efficient? Explain
Yes, Both with barter and with market exchange where people freely choose to
participate, the presumption is that they participate –they accept a deal, they
decide to buy (or sell) a commodity at the posted price –because they judge this is
in their interest.
Is voluntary exchange – barter, or participation in a competitive market – likely or
not to result in an allocation of resources that is fair and equitable? Explain
Not necessarily, If a person has a weak bargaining position, he will likely come out
less well.
What is asserted by the First Theorem of Welfare Economics?
It states that a competitive market will exhaust all the gains from trade.
What conditions are required for the First Theorem to hold?
The exchange is voluntary.
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In the diagram below, which output is socially optimal, Q0 or Q1? What area
measures the loss of producer’s plus consumer’s surplus when output Q0 is
produced? Does this diagram have any relationship to the First Theorem of
Welfare Economics?
Q1 maximizes consumer’splus producer’s surplus, which amounts to the areas
A+B+C+E.
The combined surplus associated with Q0 is smaller –it amounts to the areas
A+B+C
What is meant by “gains from trade”?
The benefit that each party to a trade.
If there were no gains from trade, would you expect a trade to occur?
No
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Suppose the minimum value of an item (the WTA) to the seller is $120 while the
maximum value (the WTP) for the buyer is $180. What is the size of the potential
gains from trade?
The potential gains from trade is the difference between the WTP value to the
buyer and the WTA value for the seller. In this case, the gains from trade amount
to $60 = 180 –120.
What is the connection between gains from trade and Pareto efficiency?
If a trade exists that would generate gains to both parties, then the original
situation cannot have been paerto efficient.
What are transactions costs?
Transaction costs are the costs of making a transaction and of enforcing it, once
made
How do transactions costs affect gains from trade?
They eat into the gains from trade, maybe nullifying them totally.
Given two consumers and two commodities to be divided up among them, what is
an initial allocation?
An initial allocation is an initial division of the total quantities of the two goods
between the two people, giving each person a particular quantity of each good,
Given an initial allocation, what is the bargaining outcomes region?
The bargaining region is the set of exchanges such that the reallocation makes
neither person worse off
Can one predict with any precision how the gains from trade will be divided up
between the two parties?
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We cant predict
Given an initial allocation, where will the process of exchange end?
What is the consumers’ contract curve?
It is the set of allocations fro which no further exchange would be pareto
improving
Given an initial allocation, can we predict where along the consumers’ contract
curve the bargaining will end up?
The process of exchange will end somewhere along the portion of the consumers’
contract curve within the bargaining region.
BEYOND THE PARETO CRITERION
What is the Utility Possibility Frontier? What does it depict?
it depicts the jointly maximal levels of uA and uB that are attainable, given the
available resources and technology.
How is the Utility Possibility Frontier related to the consumers’ contract curve?
Consumers contract curve shows the allocation of commodities that are pareto
efficient
What can you say about points on the Utility Possibility Frontier?
A point lying on the upf frontier is pareto efficient
What can you say about points inside the Utility Possibility Frontier?
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Is not paerto efficient
Is a move from a point inside the Utility Possibility Frontier to a point on the
frontier necessarily Pareto improving?
Not necessarily
Is a move from one point on the UPF to another point on the frontier Pareto
improving?
no
What does it mean to say that the Pareto criterion provides only an incomplete
ordering of outcomes?
It means that we can only compare some pairs of points in the UPF diagram
What is the tyranny of the status quo?
There is an analogy between applying the Pareto Principle as a criterion for
judgment and committee decision making where the committee has a rule, that
no motion can pass if a single committee member votes against it. The Pareto
Principle –requiring that any change be Pareto improving –is like each committee
member holding a veto power. The veto power makes it difficult for the
committee to agree on changes and creates a strong degree of inertia.
What is a Potential Pareto Improvement?
A potential Pareto improvement is a change where those who gain from the
change could fully compensate the losers and still come out ahead themselves.
How is the Compensation Principle applied?
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You apply the Compensation Criterion by adding up the gains to all those who
gain, adding up all the losses to all those who lose, and then comparing the two
totals
Does the compensation principle play any role in cost-benefit analysis?
Yes
Does the Compensation Principle require actual payment of compensation?
No
Does the Compensation Principle provide a more complete assessment of
outcomes?
yes
How does the compensation principle deal with fairness and equity?
It entirely disregards fairness and equity.
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