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Published by: SheidaHa on Jun 24, 2012
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Graduate Diploma - MicroeconomicsE. Sciubba - Lecture 9
Pareto optimalityand market allocation
Recall main result from previous lecture: Pareto op-timal allocations are such that indierence curves aretangent.First fundamental theorem of welfare economics: if markets are competitive, the market allocation is Paretooptimal.Why?
If markets are competitive, individuals take prices asgiven and choose a bundle such that:marginal rate of substitution = price ratioGiven that all individuals face the same prices, thenmrs for A = mrs for BHence at a competitive market equilibrium, the indif-ference curves for the two individuals are tangent.Decentralised trading (markets) gives us the same so-lution as bilateral bargaining.
The importance of the First Welfare Theorem is that itgives us a general mechanism - the competitive market- that we can use to ensure Pareto ecient outcomes.If there are only two agents involved, this doesn't mat-ter very much; it is easy for two agents to get togetherand examine the possibilities for mutually benecialtrades. But if there are thousands of people involved?Very simple informational requirement: we only needto look at the market price for a good.

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