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Tools of Normative Analysis
CHAPTER 3 Tools of Normative Analysis McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
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Welfare Economics Welfare Economics – branch of economic theory concerned with the social desirability of alternative economic states
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Edgeworth Box y x Eve r 0’ v w u Fig leaves per year s Adam
Box and dimensions initially set 1st click – place point v 2nd click – draw horizontal line uw 3rd click – draw vertical line xy s Adam Apples per year
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Indifference curves in Edgeworth Box
Eve r A3 E1 0’ A2 E2 A1 E3 Fig leaves per year Box and dimensions initially set 1st click – Adam’s indifference curves 2nd click – Eve’s indifference curves s Adam Apples per year
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Making Adam better off without Eve becoming worse off
Ap r 0’ Ah g Ag Eg h A Pareto Efficient Allocation Fig leaves per year p Box and dimensions initially set 1st click – “A Pareto efficient allocation” and arrow s Adam Apples per year
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Making Eve better off without Adam becoming worse off
0’ Ag g Eg p Fig leaves per year Ep1 Box and dimensions initially set 1st click – “A Pareto efficient allocation” and arrow p1 A Pareto Efficient Allocation s Adam Apples per year
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Making both Adam and Eve better off
Ap2 r 0’ g Ag Eg Pareto efficient Pareto improvement Ep2 p Fig leaves per year p2 p1 Box and dimensions initially set 1st click – Box with Pareto efficient and improvement within s Adam Apples per year
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Starting from a different initial point
Eve Ap2 0’ r g Ag Eg k p4 Ep2 p3 Fig leaves per year p p2 Box and dimensions initially set 1st click – p1 s Adam Apples per year
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The Contract Curve Eve r 0’ g Eg The contract curve p4 Ep2
Ap2 r 0’ g Ag Eg The contract curve p4 Ep2 p3 Fig leaves per year p p2 Box and dimensions initially set 1st click – contract curve drawn from lower left to upper right and “The contract curve” and arrow appear p1 s Adam Apples per year
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Pareto Efficiency in Consumption
MRSaf = MRSaf Adam Eve
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Production Possibilities Curve
│Slope│ = marginal rate of transformation Fig leaves per year w y Axes and labels 1st click – PPC and labels 2nd click – lines x and w 3rd click – lines z and y C x z Apples per year
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Marginal Rate of Transformation
MRTaf = Marginal rate of transformation of apples for fig leaves MRTaf = MCa/MCf
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Efficiency Conditions with Variable Production
Adam Eve MRTaf = MRSaf = MRSaf MCa/MCf = MRSaf = MRSaf Adam Eve
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The First Fundamental Theorem of Welfare Economics
MRSaf = Pa/Pf MRSaf = MRSaf MCa/MCf = Pa/Pf MRTaf = Pa/Pf Pa/Pf = MCa/MCf Adam Eve Adam Eve Each line wipes right after click
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Efficiency versus Equity
Eve r 0’ p3 Fig leaves per year Box and dimensions initially set 1st click – contract curve drawn from lower left to upper right and “The contract curve” and arrow appear q p5 s Adam Apples per year
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Utility Possibilities Curve
Adam’s utility U p3 Axes and labels 1st click – Utility possibilities curve, p3 and p5 2nd click - q p5 q U Eve’s utility
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Social Indifference Curve
W = F(UAdam, UEve) Adam’s utility Increasing social welfare Axes and labels 1st click – the arrow (speed: medium) and “Increasing social welfare” Eve’s utility
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Maximizing Social Welfare
Adam’s utility i iii Axes, labels, and social indifference curves 1st click – utility possibilities curve and points ii Eve’s utility
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Market Failure Market Power Nonexistence of Markets Monopoly
Asymmetric information Externality Public good
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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?
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