1. Imperfect Markets and Welfare ECO 362 29/8/13 Dr. Watson AUN

2. People are Rational  Making “right” choices: Maximize utility  People think at the margin – marginal cost  Preference  Have GOALS.  Make choices in order to fulfill those goals  Preferences complete  Preferences transitive  Bananas>apples>papaya>banana

3. What are your goals?  Graduate  Get a job  Work for customs  Governor of CBN  Graduate school – higher degrees  N N N N N N N  4.0 this semester  Go out there somewhere. Do research  Write a fantasy book; religion book  See my children married and happy  Stay awake during this class

4. Self-Interested  Trying to please yourself  Trying to make yourself better off  Doing this to make you happy  Needs come before everyone else  NOT SELF-CENTERED  I am happy when my kids are happy  In ECO 301, we ignore other people  Others can be in my utility function

5. Why do markets work?  If I make my customers happy, I become rich  Social awareness provides intrinsic value  As customer, I trade money for something I need more.  Producer does not value the stuff as much as the consumer. Producer wants to buy something else and needs money to do it.  Coffee bean video: http://www.youtube.com/watch?v=yOY91E7htXU http://www.youtube.com/watch?v=yOY91E7htXU

6. What are the conditions?  Craftsmanship and quality  Demand – need  People who CAN and WILL spend money  Market PLACE  Sufficient supply  Inputs, factors of production  Trust - http://www.youtube.com/watch?v=79ZosnxGKgk http://www.youtube.com/watch?v=79ZosnxGKgk  Why thieves hate free markets  Transparency  Thick markets – lots ofbuyers/sellers  Princess Academy by Shannon Hale

8. The market works. Hunh?  Everybody is “happy”  Goods have to move freely  A: Efficient allocation of resources  1. Resources used to their full productive capacity  Prices tell us  2. Resources used to make people as happy as possible  PARETO EFFICIENCY

9. Pareto Improvements

10. Pareto  Pareto improvement: I can make at least one person better off without making anyone else worse off.  DOES NOT NOT NOT mean:  If you cannot make anyone better off without making someone else worse off, DON’T do it  In that case, Pareto says: “????”

11. First Welfare Theorem  Given some assumptions  ANY competitive equilibrium is Pareto efficient  Perfect Information  Complete markets  Price-taking behavior  Marginal social benefits/costs = private

12. Second Welfare Theorem  Given some more assumptions  You can reach ANY Pareto outcome using a competitive equilibrium through lump sum transfers  PLUS  No increasing returns to scale What the government needs  Perfect knowledge of tastes and production  Perfect benevolence  All power of enforcement

13. Homework  Watch the following video on why markets do not work in Africa  http://www.youtube.com/watch?v=WFs MJi9tRok http://www.youtube.com/watch?v=WFs MJi9tRok  For each case study in the video, identify which of the assumptions of the 1 st and 2 nd Welfare Theorems are failing and why.