Site MapHelpFeedbackChapter Summary
Chapter Summary
(See related pages)

  1. The nature of general equilibrium
    1. Interdependence between markets is important for two reasons. First, factors that affect supply and demand in one market can have significant ripple effects in other markets. Second, interdependence produces feedback.
    2. To be completely general, equilibrium analysis would need to encompass every market in the world economy. For reasons of practicality, economists usually focus on markets that are clearly linked, ignoring others.
  2. Positive analysis of general equilibrium
    1. In a market with just two goods, general equilibrium corresponds to a point of intersection between two market-clearing curves.
    2. The general equilibrium effects of a tax may differ considerably from the partial equilibrium effects. The effect of a sales tax on the price of a good becomes larger when we account for feedback from the market for a complement, and smaller when we account for feedback from the market for a substitute.
  3. Normative criteria for evaluating economic performance
    1. Economists evaluate economic performance on the basis of efficiency and equity.
    2. The economy is wasteful (or inefficient) if it’s possible to reallocate resources in a way that makes at least one consumer better off without hurting someone else. It is Pareto efficient if there is no waste.
    3. Pareto efficient allocations are associated with utility levels that lie on the utility possibility frontier.
    4. Some notions of equity are process-oriented—for example, the idea that markets are fair because they reward people for effort and ingenuity.
    5. Outcome-oriented notions of equity are based on the distribution of either well-being or consumption and include utilitarianism, Rawlsianism, and egalitarianism. The distribution of well-being may, however, be impossible to measure.
    6. A social welfare function can capture concerns about efficiency, as well as outcome-oriented notions of equity.
  4. General equilibrium and efficient exchange
    1. To illustrate allocations and competitive equilibrium in an exchange economy, economists often use an Edgeworth box.
    2. The first welfare theorem tells us that competitive general equilibria are Pareto efficient.
    3. To identify efficient allocations of consumption goods in an Edgeworth box, we look for points where two consumers' indifference curves touch but do not cross. At efficient interior points, the two curves lie tangent to the same straight line, implying that the two consumers have the same marginal rate of substitution. This result is known as the exchange efficiency condition.
    4. Competitive equilibria satisfy the exchange efficiency condition because every consumer chooses a point at which his marginal rate of substitution equals the same price ratio.
    5. When an allocation is inefficient, consumers can mutually benefit from further trade. When an allocation is efficient, no further trade is mutually beneficial.
    6. In an Edgeworth box, each point on the contract curve corresponds to a point on the utility possibility frontier. The contract curve includes both equal and highly unequal allocations.
  5. General equilibrium and efficient production
    1. To identify efficient allocations of inputs in an Edgeworth box, we look for points where the isoquants for two firms touch but do not cross. At efficient interior points, the two curves lie tangent to the same straight line, implying that the two firms have the same marginal rate of technical substitution. This result is known as the input effciency condition.
    2. In an Edgeworth box, each point on the production contract curve corresponds to a point on the production possibility frontier.
    3. To identify efficient levels of production in a oneconsumer economy, we look for a point where the PPF and an indifference curve touch but do not cross. At efficient interior points, the two curves lie tangent to the same straight line, implying that the firm’s marginal rate of transformation equals the consumer’s marginal rate of substitution. This result, which also holds with more than one consumer, is known as the output efficiency condition.
    4. The first welfare theorem holds in production economies. Competitive equilibria satisfy the input efficiency condition because every firm chooses a point at which its marginal rate of substitution equals the same input price ratio. Competitive equilibria also satisfy the output efficiency condition because firms and consumers face the same prices. Each consumer chooses a bundle for which his marginal rate of substitution equals the price ratio for the goods in question. Firms choose production levels at which the marginal rate of transformation equals the same price ratio.
    5. Market failures may prevent free markets from operating efficiently. Also, competitive equilibrium allocations may be extremely inequitable across consumers. Either consideration may justify government intervention in markets. However, even in cases where improvements are possible, governments may introduce new inefficiencies.
  6. Equity and redistribution
    1. The second welfare theorem implies that, in principle, societies can use competitive markets to achieve both efficiency and equity. Doing so requires lump-sum transfers to improve the initial allocation of consumption goods.
    2. In practice, governments cannot achieve their distributional goals through lump-sum transfers. Instead, taxes and transfers are linked to choices, which creates a trade-off between equity and efficiency.







Bernheim: Microeconomics 1eOnline Learning Center

Home > Chapter 16 > Chapter Summary