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Economic Efficiency

Economic Efficiency. An allocation of resources is said to be efficient if it is not possible to make one or more persons better off without making at least one other person worse off (applying the Pareto criterion).

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Economic Efficiency

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  1. Economic Efficiency An allocation of resources is said to be efficient if it is not possible to make one or more persons better off without making at least one other person worse off (applying the Pareto criterion). Efficiency in allocation requires that three efficiency conditions are fulfilled:- efficiency in consumption, - efficiency in production, and - product-mix efficiency.

  2. Efficiency in Consumption BY Axa Axb A0 AX IB1 I = indifference curve possible allocation of fixed amounts of X and Y between consumers A and B IB0 IA a BYa AYa b BYb AYb BX B0 BXa BXb AY in b the marginal rates of utility substitution are equal; MRUSA = MRUSB

  3. A Set of Efficient Consumption Allocations BY A0 AX A C A A A B B A B A B B C B BX B0 AY C = contract line that links efficient consumption good (X,Y) allocations between A and B consumers

  4. Efficiency in Production KY Lxa Lxb X0 LX IY1 IY0 I = isoquant the possible allocation of fixed amounts of inputs (L and K) to produce X and Y consumption goods IX a KYa KXa b KYb KXb LY Y0 LYa LYb KX in b the marginal rates of technical substitution are equal; MRTSX = MRTSY

  5. Product-Mix Efficiency Y if MRUSA = MRUSB, the slopes of individuals' indifference curves are the same => one I. MRUS = MRT YM a Ya b Yb I Yc c Production Possibility Curve/Transformation Curveusing all the available resources XM 0 Xa Xb Xc X in b the marginal rates of transformation are equal: MRTL = MRTK = MRUSA = MRUSB

  6. WELFARE MAXIMISATION Product Possibility/ Production Space Utility Possibility /Space X0Y0 and X1 and Y1 are Product Mixes UU’ is the Grand Utility Frontier Each point represents MRPT = MRS for each product Mix)

  7. WELFARE MAXIMISATION Assumptions - Grand Utility Frontier acts like the Budget constraint and W1-W4 are the desired levels of Welfare. Tangential point is the Point of Maximum Satisfaction . Point of Welfare Maximization is Pareto Optimal State Pareto optimality is necessary but not a sufficient condition for Welfare maximization. Pt L is on a higher Welfare than Pt N .

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