Instructor Name: Muhammad Yasar

GENERAL EQUILIBRIUM
LECTURE # 2
MSC ECONOMICS (EVE)
3RD SEMESTER

Prepared by Muhammad Yasar

 Source: Chapter # 23 , Modern Microeconomics by A.
Koutsoyiannis
WELFARE ECONOMICS
 Now when we are familiar with the instrument
(Edgeworth Box) to do the general equilibrium
analysis.

Prepared by Muhammad Yasar

 We start our quest by understanding different
theories regarding optimum solution.
SMITH’S MODEL

According to Smith welfare means increase in the

Prepared by Muhammad Yasar


wealth of the society.
 Wealth of the society means by GNP

 When GNP rises it will increase the employment as

well as the consumption.
 Assumption: distribution of income is equitable.
 BENTHAM’S MODEL

 It has the concept for welfare we mean greater good for

the greater number.

Prepared by Muhammad Yasar

 Let us consider the following equation to understand

 w = Ua+Ub+Uc
 Let Ua and Ub increases and Uc decreases

 Condition, (∆Ua+ ∆Ub) > ∆Uc

 Then we will say that there is an increase in the

wealth so is the welfare.
PROBLEM

 Who matters more in a society?

Prepared by Muhammad Yasar

 Who is more disserving?

 Who is more important in society?

 What if greater good for greater number not exist?

 PARETO OPTIMALITY

 Vilfredo Pareto developed the model.

 The ideal condition defined, “Impossible to make one

Prepared by Muhammad Yasar

better off and other no worse off ”.
 Three marginal conditions

a. Efficiency of distribution among commodities

b. Efficiency of allocation of factors among the firms

c. Efficiency in the allocation of factors among

commodities
 Prepared by Muhammad Yasar
EDGEWORTH BOX
 PARETO OPTIMALITY

 At points c, o and b we can see all the IC of consumer

A and B having same slopes.

Prepared by Muhammad Yasar

 On the contract curve we have (MRSX,Y)A = (MRSX,Y)B
 When we move from point c to b we can see Consumer
A is having increase in his satisfaction.
 On the other hand B is at lower satisfaction level.
 But due to the optimality condition both consumers
have been balanced.
 Therefore, one is better off and other is not worse.
PRODUCT MIX

 MRPTX,Y = (MRSX,Y)A = (MRSX,Y)B

 MRPT = Marginal Rate of Product Tranformatio

Prepared by Muhammad Yasar

 MRPT is the slope of PPF, therefore,

 MRPTX,Y = ∆Y/∆X

 It means change in Y per unit of X

 PRODUCT MIX EXAMPLE

 Let us consider that

MRPT = 2 MRS = 1

Prepared by Muhammad Yasar

 This means that producers are willing to produce 1X
by giving away 2Y.
 Consumers are willing to exchange 1X with 1Y.

 So, firms producing less X from Y they should increase

their transformation rate to catch up the consumer’s
exchange rate.
 PRODUCT MIX EXAMPLE

 So, by making it 2X =2Y or 1X = 1Y the product mix

will be achieved.

Prepared by Muhammad Yasar

 It can also be said in a way that producer should value
X less and Y more.
 So, the product mix achieved.

MRPTX,Y = (MRSX,Y)A = (MRSX,Y)B

Prepared by Muhammad Yasar
THANK YOU