Chapter 3-Tools of Normative Analysis Public economics
1 Chapter 3 - Tools of Normative Analysis Public Economics
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 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
Pure exchange economy Economy with 2 people(Adam Eve) 2 commodities(Apples Figs Fixed supply of commodities(e. g, on a desert island) An Edgeworth Box depicts the distribution of goods between the two people
3 Pure exchange economy • Economy with – 2 people (Adam & Eve) – 2 commodities (Apples & Figs) – Fixed supply of commodities (e.g., on a desert island) • An Edgeworth Box depicts the distribution of goods between the two people
Figure 3. 1 Ey Adam← Apples per year
Figure 3.1
Pure exchange economy Each point in the box in Figure 3. 1 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 Ov of apples, and Ow of gs
5 Pure exchange economy • Each point in the box in Figure 3.1 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
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
6 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
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 E3 compared E2 or E
7 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 E3 compared E2 or E1
Figure 3.2 Eve E3 Er E A Apples per year
Figure 3.2
Pure exchange economy Suppose some arbitrary point in the edgeworth Box is selected, for example point g in Figure 3.3 This provides an initial allocation of goods to Adam and eve and thus some initial level of utility
9 Pure exchange economy • Suppose some arbitrary point in the Edgeworth Box is selected, for example point g in Figure 3.3. • This provides an initial allocation of goods to Adam and Eve, and thus some initial level of utility
Figure 3.3 E Eg g A Pareto efficient allocate Adam Apples per year
Figure 3.3
