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ECON 230D1 (30)
Chapter 10

ECON 230D1 Chapter 10: Summary

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McGill University
Economics (Arts)
ECON 230D1
Irakli Japaridze

Chapter 10: General Equilibrium and Economic Welfare General Equilibrium - Eq is efficient when consumption ( if goods cannot be reallocated across people so that someone is better off and no one is harmed) and production (if it is impossible to produce more output at the given cost) are efficient. - Pareto principle: a change that makes a person better off without harming anyone else is good. An allocation is pareto efficient if any possible reallocation would harm at least one person. - partial-eq analysis: an examination of eq and changes in eq in one market in isolation. in contrast with general-eq analysis: the study of how eq is determined in all markets simultaneously. Multimarket-eq analysis only focuses on the relevant markets (like complements and substitutes, output and input, etc) - Min wage causes Q labor demanded to be less than S. However, in a gen-eq analysis, not always applied - When this happens, Q in a covered sector goes down and goes up in an uncovered sector and becomes residual S curve. Wage falls in uncovered sector. Incomplete coverage= living-wage (above poverty) Trading between two people -Free trade is Pareto efficient: -A common tool in general equilibrium analysis is the Edgeworth box which allows the study of the interaction of two individuals trading two different commodities. -Should individuals trade? Depends on: •Utility maximisation •Usual shaped indifference curves (convex shaped) •Nonsatiation (each person has strictly positive marginal utility for each good) •No interdependence (one’s utility doesn't depend on the other’s consumption and one’s consumption doesn't harm the other’s) - Prefer a bundle in the middle to w: trade will allow the situation to be Pareto efficient - When indifference curve is tangent, MRS of both individuals is equal, so no further trade possible - Contract curve contains all Pareto efficient allocations, the points on it represent optimal allocation - Bargaining ability: if one individual is better at bargaining, then can choose a bundle in between indiff curves that leaves other individual at least as well off as bundle w Competitive exchange - A competitive market has two advantages: • The first theorem of welfare economics: the competitive eq is Pareto efficient • The second: any efficient allocation can be achieved by competition/competitive exchange - In a competitive market, prices adjust until the Q supplied = Q demanded. When D=S, competitive eq - In a competitive eq, both individual’s indifference curves are tangent at the same bundle on the price line, meaning that slopes of indifference curves (MRS) are equal to each other and to the price line. Therefore competitive eq must be on the contract curve = 1st theorem has been proven - Any Pareto efficient bundle x can be obtained as a competitive eq if initial endowment is x, meaning that any Pareto-efficient eq can be obtained by co
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