Describe the two branches of general equilibrium analysis.
General equilibrium analysis describes economic markets in two distinct ways. The first describes economic markets as they are in the real world. The second branch of general equilibrium analysis aims to describe markets as they ought to exist, and attempts to define what constitutes an efficient or equitable market.
Social welfare functions combine the utility levels of everyone in society into a single index. List three types of social welfare functions and discuss what they mean.
We looked at three types of social welfare functions: utilitarian, Rawlsian, and egalitarian. A utilitarian social welfare function is simply the total sum of every individual’s welfare. In the Rawlsian worldview, social welfare is determined by the utility of the worst-
How do economists generally define efficiency in a market?
Most economists consider a market’s efficiency using the concept of Pareto efficiency. A Pareto-
What are the three requirements of an efficient market?
In order for an economy to be considered efficient, it must exhibit exchange, input, and output efficiency.
What can the Edgeworth box be used to examine? What does an Edgeworth box plot?
The Edgeworth box can be used to examine market efficiency, including exchange, input, and output efficiency. It plots the allocation of two goods (products or inputs) between two economic actors (either consumers or firms).
What is the relationship between consumers’ marginal rates of substitution and the goods’ prices in an efficient market? How can this relationship be seen in an Edgeworth box?
Two goods are allocated efficiently when the consumers’ marginal rates of substitution are equal to the ratio of the goods’ prices. A Pareto-
How does the consumption contract curve relate to Pareto efficiency?
The contract curve is the line that shows the collection of all possible Pareto-
What does input efficiency imply about the relationship between the marginal rate of technical substitution and input prices? How can this relationship be seen in an Edgeworth box?
An economy exhibits input efficiency when the two firms’ marginal rates of technical substitution equal the ratio of the wage rate to the capital rental rate. An efficient input allocation can be found at the tangency between the two firms’ isoquants.
How does the production contract curve relate to Pareto efficiency?
Similar to the contract curve for consumers, the production contract curve is the line that shows the collection of all possible Pareto-
How does the production possibilities frontier relate to the marginal rate of transformation?
The marginal rate of transformation is the tradeoff between how much of one output must be given up to gain an additional unit of the other output. This can be seen on the production possibilities frontier—
What conditions are required for the First Welfare Theorem to hold?
The First Welfare Theorem relies on many conditions that often do not hold in the real world. The first assumption is that firms operate in a perfectly competitive market. The theorem also relies on the absence of market power and of several concepts explored in the next chapter—
What does the Second Welfare Theorem predict?
The Second Welfare Theorem predicts that every Pareto-