(10.3) Normative analysis

Question 1

Individual welfare and social welfare (pareto efficiency) are examples of (…) analysis

Answer 1

normative

Question 2

1

Define revealed preferences

Answer 2

If rational individuals choose option A when option B is available, we infer A is preferred to B

Question 3

2

What is required for normative evaluation of revealed preferences

Answer 3

assumption of rationality

(also can compare choices, etc)

Question 4

1

Describe the usefulness of revealed preferences to normative evaluation

Answer 4

• Creates a direct link between observed behavior and individual welfare

Question 5

1

What do we assume producer surplus to be equal to?

Answer 5

Firm profit

Question 6

1

Why is moving from individual to social welfare difficult?

Answer 6

it involves comparing different people’s well-being

Question 7

2

When will situation A Pareto dominate situation B?

Answer 7

• Under A, all individuals are at least as well off as under B
• At least one individual is strictly better off under A

Question 8

2

Define pareto efficiency

Answer 8

• A situation is Pareto efficient if no other feasible situation Pareto dominates it
• i.e. no policy change can make everyone better off

Question 9

2

Describe the limits of pareto efficiency

Answer 9

• Completely ignores distributional concerns and inequality
• A situation where one person has everything and everyone else has nothing could be Pareto efficient

Question 10

2

Describe how we compute consumer surplus in markets and potential issues with this

Answer 10

• Total consumer surplus = sum of all individual consumer surpluses
• Issue of inequality: equal total welfare whether distributed equally or concentrated

Question 11

1

What makes normative analysis more complex?

Answer 11

When individuals are not rational

Question 12

2

Define liberal paternalism

Answer 12

• Conflct between respect for free choice and telling people what to do via govt
• Occurs when behavioral models suggest people make suboptimal choices

Question 13

3

Describe the 1st welfare theorem

Answer 13

• Perfect competition leads to Pareto effcient allocation
• Markets maximize the sum of consumer and producer surplus
• Any government intervention reduces total surplus

Question 14

2

Describe the 2nd welfare theorem

Answer 14

• Any desired Pareto efficient allocation can be achieved through perfect competition
• BUT: Requires redistributing initial wealth - which is politically very difficult