ECON 100B Lecture Notes - Lecture 12: Edgeworth Box, Pareto Efficiency, Invisible Hand
23 May 2018
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Econ 100B Lecture 12 - May 22, 2018
General Equilibrium
Review:
●Any policy intervention affects multiple markets at the same time
●Compared to partial equilibrium analysis, GE allows economists to account got
interactions among markets
●Quantitatively, solving for the market equilibrium condition simultaneously in two or
more markets will give the GE price and quantities
●GE analysis also allows economists to analyse the efficiency of an economy
●3 ways to analyse efficiency in an economy
○Exchange efficiency
○Input efficiency
○Output efficiency
●Exchange efficiency: allocation of a set of goods must be Pareto efficient (PE)
●PE allocation: once an economy has reached PA allocation, no consumer can be made
better off in her consumption without making someone worse off
●We identify Pareto efficient allocations using a tool called the Edgeworth box
●Edgeworth box: takes advantage of one of the assumptions that we make in analyzing
exchange efficiency
Pareto Efficient
● GE analysis of market interactions with feedback and spillover effects helped us
determine the equilibrium price and quantity in interdependent markets
● The other question we can answer using GE analysis: how well the market allocates
goods. Is the allocation ‘desirable’ for the society?
● Concept of Pareto Efficiency: Allocation of goods is considered Pareto efficient if no one
can be made better off without making someone worse off
● Pareto Efficiency- it is a standard to measure market outcomes.
● Adam Smith’s ‘invisible hand’ emphasizes the point that market outcomes can be Pareto
efficient under a certain set of assumptions
○ one of them is perfect competition
● An important feature: the Pareto efficient allocation need not be ‘fair’
○ Extreme scenario- As long as people have positive valuation of goods (positive
marginal utility), giving one person everything in the economy and everyone else
nothing is Pareto Efficient
● Efficiency of market outcomes can be judged based on three basic condition: Exchange
efficiency, Input efficiency, and Output efficiency
● Exchange efficiency: given a certain level of income/ endowment the allocation of a set
of goods across people must be Pareto efficient.
○ People have a set of goods with them and they exchange if they want to
Document Summary
Econ 100b lecture 12 - may 22, 2018. Any policy intervention affects multiple markets at the same time. Compared to partial equilibrium analysis, ge allows economists to account got interactions among markets. Quantitatively, solving for the market equilibrium condition simultaneously in two or more markets will give the ge price and quantities. Ge analysis also allows economists to analyse the efficiency of an economy. 3 ways to analyse efficiency in an economy. Exchange efficiency: allocation of a set of goods must be pareto efficient (pe) Pe allocation: once an economy has reached pa allocation, no consumer can be made better off in her consumption without making someone worse off. We identify pareto efficient allocations using a tool called the edgeworth box. Edgeworth box: takes advantage of one of the assumptions that we make in analyzing exchange efficiency. Ge analysis of market interactions with feedback and spillover effects helped us determine the equilibrium price and quantity in interdependent markets.
