welfare economics - abrell.euabrell.eu/wp-content/uploads/2018/03/2_welfare_economics.pdf ·...

||

Jan AbrellCentre for Energy Policy and Economics (CEPE)D-MTEC, ETH Zurich

1

Welfare Economics

Welfare Economics 06.03.2018

||

Outline

• So far• Basic Model• Economic Efficiency• Optimality• Market Economy• Partial Equilibrium Analysis• Summary

06.03.2018Welfare Economics 2

||

Summary: Economy in the Environment

(1) Basic life-support functionHardly substitutable

(2) Amenity services• Often no resource use but rivalry in

consumption • Partly substitutable by capital


||

(3) Waste sink/pollution• Stock and flow pollution• Global and local pollution• Substitution using recycling or mimicking

waste sink services

(4) Natural resources• Stock and flow resources• Stock resources can be renewable• Substitution by technology change, i.e., more

efficient resource


Summary: Economy in the Environment

||

Summary: Drivers of Environmental Impacts

IPAT identity:

Kaya’s identityIPAT for CO2 defining technology as the product of energy and carbon intensity

Environmental Kuznet Curve: Reasons:

Scale and composition effects, technological change, environmental regulation

Weak empirical evidences for EKC for local but not for global pollutants


||

How do we efficiently allocate commodities/resources in an economy?

How do we optimally allocate commodities/resources in an economy?

Are markets a good tool to implement these allocation?

What happens if we relax the assumptions of the basic model? Public goods Externalities


Today: Basic Model of Welfare Economics

||

Outline



||

Consumers(denoted by i)

Firms(denoted by f)

Commodities(denoted by c)

Natural environment


What is An Economy?

||

Commodities, goods, resources: 𝑋𝑋𝑐𝑐used to gain utility and produce other commodities (transformation)

Main assumption:Commodity usage is private

Commodity types: Standard goods Primary factors Natural resources


What are commodities?

||

Consumer i gains utility 𝑈𝑈𝑖𝑖 consuming commodity c:

Main assumptionNo externalities: Utility only depends on own consumption

Marginal utility is positive but decreasing

Indifference curveLocus of all consumption bundles that provide the same utility level


Consumers

|| 06.03.2018Welfare Economics 11

The Marginal Rate of Substitution (MRUS)

Graphically MRUS is the slope of an indifference curve

IntuitivelyMRUS tells how much of y is needed to compensate a change in x (holding utility constant)

MRUS provides measure of substitutability of commodities

||

Use commodities and produce other commodities c’ (output):

Production function expresses transformation technology

Main assumption:No externalties: Output only depends on own inputs

Marginal rate of technical substitution (MRTS)Amount of (e.g.) capital (K) needed to give up (e.g.) a unit of resources (R) holding output constant (= slope of isoquant)


Firms

||

AllocationDescribes how we distribute resources among consumers and firms

Economicsanalyzes allocations and how we efficiently (or optimally) allocate resources among individuals


Allocation

||

Social plannerDirectly chooses allocation

Market EconomyMarket and prices coordinate behavior of agents

Social planner solution serves as reference case


Social Planer vs Market Economy

||

Outline




Economic Efficiency

An allocation is Pareto-efficient (or simply efficient) if it is not possible to make one individual better off without making an other individual worse off.

||

An allocation is Pareto-inefficient(there exists an Pareto improvement) if we can make one individual better off without making another worse of

No distributional statement


Implications of Economic Efficiency

||

Consumption efficiencyAllocation of commodities among consumers

Production efficiencyAllocation of commodities among firms

Product mix efficiencyAllocation of produced and consumed commodities


Conditions for Pareto-efficiency

||

Marginal rate of substitution equalized across consumers


Efficiency in Consumption

||

Marginal rate of technical substitution equalized across firms


Efficiency in Production

||

Social indifference curve (I – I)Set of all efficient consumption bundles

Transformation curve (YM – Xm)Set of all efficiently produced outputs

Marginal rate of transformationSlope of transformation curve


Product-mix Efficiency

||

Contract curveLocus of all Pareto-efficient consumption allocations

Utility possibility curveLocus of all Pareto-efficient utility combinations

Which allocation to choose?


Pareto-efficient Allocation is not Unique

||

Outline



||

Efficiencydetermines allocations in which resources are not wasted

Optimalitychoose efficient allocation according to a welfare criterium

Social welfare function (SWF)Provides ranking of utility combinations


Optimality vs Efficiency


Social Welfare Functions are Distributional Statements

a) Purely utilitarian SWF:

b) Maxmin or Rawlsian SWF:

c) Generalized utilitarian SWF:

||

Optimality implies efficiency


Welfare Optimality Condition

Slope welfare function

Slope utility-possibility

curve

||

Welfare functions are distributional statements

Who decides? Dictator Voting (public choice)

Often used approach Provide distribution impacts for different

efficient allocations Sensitivity over slope of welfare function


Discussion

||

Outline



||

Market Economy


Market clearing (supply S satisfies demand D) determines prices p:

||

Private commoditiesCommodity used by one agent cannot be used by another

No ExternalitiesUtility/output only depends on own resource consumption

AdditionallyRegularity (technical) assumptions on utility and production functions


Assumptions on Commodities (and Functions)

Already used to determine efficiency/optimality

||

Property rights fully assigned Market can be established

Markets exist for all commodities Prices for all commodities

Perfect information for all agents No transaction costs

Perfect competition on all marketsAgents are price-takers


Assumptions on Markets

||

Given prices, consumers maximize utility given their budget (M)


Behavioral Assumptions: Consumers

Slope budget line: pX/pY

||

As all consumers face identical prices cannot manipulate prices


Market Ensures Consumption Efficiency

Slope: pX/pY

||

Given prices, firms maximize profits


Behavioral Assumptions: FirmsSlope iso-cost line: pL/pK

||

As all firms Face identical prices Cannot manipulate prices


Market Ensures Production Efficiency

Slope: pL/pK

||

Brings together consumer and producer production

As consumers and firms face identical prices cannot manipulate prices


Product Mix Efficiency

Slope: pX/pY


Fundamental Welfare Theorems

First TheoremEvery competitive equilibrium is an

Pareto-efficient allocation

Second TheoremEvery Pareto-efficient allocation can be obtained with an competitive equilibrium

(using Lump-sum transfers)

||

Outline

• So far• Basic model• Economic Efficiency• Optimality• Market Economy• Partial Equilibrium Analysis• Summary


||

General equilibrium approach Pro: Very comprehensive Con: Very difficult

Partial equilibrium approach Consider only subset of

commodities (often just one) Ignore income link


General Equilibrium is costly

||

Basic model components: Benefit (concave)

e.g., higher utility Cost (convex)

e.g., production cost

Net-benefit


Social Planner

||

Efficiency conditionMarginal Benefit = Marginal Cost


Social planner: Maximize Net-Benefit

NB

||

Demand function (D)equal to marginal benefit functionexpresses willingness to pay

Supply function (S)equal to marginal cost function

Market outcome


Market Ensures Efficiency

NB

CS

PS

||

Market solution distributes net-benefit (social surplus)

Consumer surplus (CS)Difference between maximum willingness to pay and price paid

Producer surplus (PS)Difference between price obtained and marginal cost


Distribution of Net-Benefit

CS

PS

NB

||

Outline

• So far• Basic model• Economic Efficiency• Optimality• Market Economy• Partial Equilibrium Analysis• Summary


||

Social planner solutionChoose allocation directlyServes as reference case

Market solutionAgents interact on markets given commodity prices

General questionCan market achieve social planner solution?If not, how to regulate markets?


General approach

||

An allocation is pareto-efficient (or simply efficient) if it is not possible to make one individual better off without making another worse off.

Efficiency makes no distributional statement Use welfare function to determine optimal allocation in terms of distribution


How do we evaluate allocations?Efficiency and optimality

||

Every competitive equilibrium is an Pareto-efficient allocation

Assumptions Private commodities No externalities Property rights assigned Markets for all commodities Perfect information Perfect competition


Can Markets guarantee Efficiency?First Welfare Theorem

||

Public goods (e.g. air quality)Non-rival in consumptionNon-excludability

Externalities (e.g. pollution)Individuals’ utility depends on other individuals consumption

General question What happens if we relax our assumptions?Do we have to regulate? How?


But: This is an idealized world

||Welfare Economics 49

Questions?

06.03.2018

||

Literature

Perman R., Y. Ma, J. McGilvray, and M. Common (2003): Natural Resource and Environmental Economics. Chapter 4 (Chapter 5 in 3rd edition).


welfare economics - abrell.euabrell.eu/wp-content/uploads/2018/03/2_welfare_economics.pdf ·...

Documents