Questions for Review with Answers
Chapter 22. Equilibrium and General Equilibrium. Welfare Economics. The Invisible Hand
I. Equilibrium and the Standard Supply-Demand Graph
Chapter 22 – Question 1
Economists distinguish three kinds of equilibrium. Please name them.
* (1) Partial equilibrium, which is equilibrium on the market for one particular good in a specified region, (2) general equilibrium, which is equilibrium on all of an economy's markets, (3) macroeconomic equilibrium, which is equilibrium between aggregate supply and demand.
II. General Equilibrium
Chapter 22 – Question 2
Walrasian equilibrium is based on the application of simultaneous equations. Please explain.
* Simultaneous equations are a set of two or more equations that have at least one solution in common. There must always be as many equations as there are unknowns. There are two equations for every commodity: one underlying its supply curve, another one underlying its demand curve. With the help of these two equations, the two unknowns can be found: equilibrium price and equilibrium quantity of every commodity.
Chapter 22 – Question 3
What is tatonnement?
* It is a trial-and-error process intended to find the equilibrium price. A hypothetical market co-ordinator shouts prices at random until he has brought quantity supplied and quantity demanded into equilibrium.
III. Welfare Economics
Chapter 22 – Question 4
Name the conditions for productive and allocative efficiency.
* Productive efficiency means that the economy is on the PPF, costs have been minimised, ATC is at the lowest level possible, the mix of factors cannot be improved.
Allocative efficiency means total surplus has been maximised, P = MC = MU, the mix of products cannot be improved.
Chapter 22 – Question 5
What is Pareto optimality?
* A state in which A's condition can only be improved at the expense of B's condition.
Chapter 22 – Question 6
What condition must be fulfilled for income distribution to be efficient?
* Income distribution is efficient when no income can be increased without lowering another income.
Chapter 22 – Question 7
What does the second fundamental theorem of welfare economics state?
* It states that, after suitable transfer payments and the taxes required to finance them, the market will produce Pareto-optimal results all on its own; the only government intervention needed is the right initial distribution of endowments to agents.
Chapter 22 – Question 8
And what does the compensation principle state?
* It states that situation B is superior to situation A when in B the winners could theoretically compensate the losers. This requires that the overall gain must be greater than the overall loss.
Chapter 22 – Question 9
Define inefficiency.
* When the rule of marginal-cost pricing is not obeyed, producers receive an extra surplus (the gap between the marginal-cost curve and the supply curve). This shift of potential consumer surplus to producers is not viewed as inefficient. But there is an additional loss of consumer surplus as the entire triangle depicting total surplus is smaller than it would be if goods were sold at marginal costs.
IV. The Invisible Hand
Chapter 22 – Question 10
In case you do not believe that God had the free-enterprise economy in mind when He created man, what else do you think accounts for the merits of capitalist economies?
* The abundance and variety of goods are due to competition, which leads to duplication and excess supplies. Competition is, in essence, a lack of co-ordination. Equilibrium - the absence of permanent shortages or surpluses - is in the main brought about by suppliers, who adapt quantity supplied and price to demand.
V. An Excursus on the Historical Roots of Equilibrium, Welfare Economics and the Invisible Hand
Chapter 22 – Question 11
Can you conceive any sensible reason why economics should be modelled on physics?
* The emulation of physics is attractive because for many centuries it had seemed that nature was governed by eternal laws, which can be discerned and explained. In the 2oth century, the discovery of deterministic chaos and quantum physics shed doubt on man's scientific ability to explain nature in terms of eternal laws. But be that as it may, physics deals with non-organic nature while economics deals with humans.
Chapter 22 – Question 12
Why does laissez-faire necessarily go hand in hand with increased controls but also with greater freedom?
* Laissez faire is always confined to capital owners. For the rest of the population, it means that people enjoy no protection whatsoever against capital owners. These must enforce controls to prevent the rest from doing as they please. On the other hand, there is a trade-off between protection and freedom; less protection also means more freedom.
Chapter 22 – Question 13
How would you describe the relationship between economic self-interest and the public interest?
* The economic interests of the public at large comprise high living standards, which include high incomes, high standards of health care, education, and infrastructure facilities plus stability and security of living conditions. They also include a distribution of incomes that can be considered as fair. Many of these interests can only be satisfied through taxes, which everybody evades or avoids wherever possible. So ultimately, the relationship between individual and public economic interests is paradoxical; perhaps it can best be described as a beggar-thy-neighbour phenomenon.
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