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Economics 2151B - Lecture 21.docx

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Western University
Economics 2150A/B
Kristin Denniston

Economics 2151B Wednesday March 26 Lecture 21 Chapter 16 – General Equilibrium Homework 5 • Will be posted Thursday or Friday • Covers chapter 16 & 17 Pareto Efficiency • Is the allocation of goods and inputs Pareto efficient (economically efficient)? • Fundamental Theorem: A general competitive equilibrium is Pareto efficient, which requires: 1) Exchange Efficiency • There is no way that either side can trade to increase their utility • MRS Bi= MRS Joe xy xy 2) Production Efficiency • Requires that the marginal rates of technical substitution between labour and capital in each industry are equal across the two industries (otherwise we need to reallocate our labour and capital inputs from one industry to another so both outputs can increase) • MRTS XLK= MRTS YLK 3) Substitution Efficiency • Does the level of X and Y produced match the level of X and Y demanded by consumers? Bill Joe • MRT =xyRS xy = MRS xy 1. Exchange Efficiency Bill Joe  Condition: MRS xy = MRS xy  Bill and Joe are maximizing utility subject to a budget constraint where PxX + PyY ≤ I MUx Px  Tangency Condition: = MUy Py o Says that the ratio of marginal utilities of X and Y needs to be equal to the price ratio o When consumers are utility maximizing, the benefit they get from the last dollar spent on good X is equal to the benefit they get from the last dollar spent on good Y  If the
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