Chap03 Tools of Normative Analysis.ppt

Chapter 3 - Tools of Normative Analysis
Public Economics
1
Welfare economics
Need systematic framework to assess the desirability of various government actions.
Welfare economics is concerned with the social desirability of alternative economic states.
Distinguishes cases when private markets work well from cases where government intervention may be warranted.
Relies heavily on basic microeconomic tools, particularly indifference curves.
2
Pure exchange economy
Economy with
2 people (Adam & Eve)
modities (Apples & Figs)
Fixed supply modities (., on a desert island)
An Edgeworth Box depicts the distribution of goods between the two people.
3
Figure
4
Pure exchange economy
Each point in the box in Figure represents an allocation between Adam and Eve.
Each point in the box fully exhausts the resources on the island. Adam consumes what Eve doesn’t.
Adam’s consumption of apples and figs increases as we move toward the northeast in the box.
Eve’s consumption of apples and figs increases as we move toward the southwest in the box.
At point v in the figure, Adam’s allocation of apples is Ox, and of figs is Ou. Eve consumes O’v of apples, and O’w of figs.
5
Pure exchange economy
Assume that Adam and Eve each have conventionally shaped indifference curves.
Adam’s happiness increases as he consumes more; therefore his utility is higher for bundles toward the northeast in the Edgeworth Box.
We can therefore draw “standard” indifference curves for Adam in this picture. Adam would get even higher utility by moving further to the northeast, outside of the Edgeworth Box, but he is constrained by the resources on the island.
6
Pure exchange economy
Similarly, Eve’s happiness increases as she consumes more; therefore her utility is higher for bundles toward the southwest in the Edgeworth Box.
Eve’s indifference curves therefore are “flipped around.” Her utility is higher on pared E2 or E1.
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Figure
8
Pure exchange economy
Suppose some arbitrary p