McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 3 TOOLS OF NORMATIVE ANALYSIS

3-2 Welfare Economics Welfare Economics – branch of economic theory concerned with the social desirability of alternative economic states

3-3 Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year v wu y x

3-4 Indifference curves in Edgeworth Box Edgeworth Box Adam Eve 0 0’0’ s r Apples per year Fig leaves per year A1A1 A2A2 A3A3 E1E1 E3E3 E2E2

3-5 Making Adam better off without Eve becoming worse off Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year AgAg AhAh ApAp EgEg g h p A Pareto Efficient Allocation

3-6 Making Eve better off without Adam becoming worse off Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year AgAg EgEg g p1p1 p E p1 A Pareto Efficient Allocation

3-7 Making both Adam and Even better off Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year AgAg EgEg g p1p1 p E p2 A p2 p2p2 Pareto efficient Pareto improvement

3-8 Starting from a different initial point Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year AgAg EgEg g p1p1 p E p2 A p2 p2p2 p3p3 p4p4 k

3-9 The Contract Curve Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year AgAg EgEg g p1p1 p E p2 A p2 p2p2 p3p3 p4p4 The contract curve

3-10 Pareto Efficiency in Consumption MRS af = MRS af Adam Eve

3-11 Production Possibilities Curve Apples per year Fig leaves per year C C 0 w y xz │Slope│ = marginal rate of transformation

3-12 Marginal Rate of Transformation  MRT af = Marginal rate of transformation of apples for fig leaves  MRT af = MC a /MC f

3-13 Efficiency Conditions with Variable Production MRT af = MRS af = MRS af MC a /MC f = MRS af = MRS af AdamEve AdamEve

3-14 Efficiency versus Equity Edgeworth Box Adam Eve 0 0’ s r Apples per year Fig leaves per year q p5p5 p3p3

3-15 Utility Possibilities Curve Eve’s utility Adam’s utility U U p3p3 q p5p5

3-16 Social Indifference Curve Eve’s utility Adam’s utility W = F(U Adam, U Eve ) Increasing social welfare

3-17 Maximizing Social Welfare Eve’s utility Adam’s utility i ii iii

3-18 Market Failure  Market Power monopoly  Nonexistence of Markets asymmetric information externality public good

3-19 Buying into Welfare Economics  Individualistic outlook merit goods  Results orientation  Coherent framework for analyzing policy Will it have desirable distributional consequences? Will it enhance efficiency? Can it be done at a reasonable cost?