[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. General equilibrium in the basic competitive model
occurs when wages, interest rates, and prices are such
that demand is equal to supply in all labor, capital, and
product markets. All markets clear.
2. The competitive equilibrium maximizes the sum of consumer
and producer surplus.
3. Under the conditions of the basic competitive model,
the economy’s resource allocation is Pareto efficient:
that is, no one can be made better off without making
someone worse off.
4. The distribution of income that emerges from competitive
markets may be very unequal. However, under the
conditions of the basic competitive model, a redistribution
of wealth can move the economy to a more equal
allocation that is also Pareto efficient.
5. Changes in one market will have effects on other markets.
To analyze the effects of a tax, for example, general
equilibrium analysis takes into account the effects in all
markets. But when the secondary repercussions of a
change are small, partial equilibrium analysis, focusing
on only one or a few markets, is sufficient.
KEY TERMS
general equilibrium
producer surplus
deadweight loss
Pareto efficient
exchange efficiency
production efficiency
product-mix efficiency
marginal rate of transformation
partial equilibrium analysis
general equilibrium analysis
REVIEW QUESTIONS
1. How does the economy in general equilibrium answer
the four basic economic questions: What is produced,
and in what quantities? How are these goods produced?
For whom are they produced? Who makes the economic
decisions?
2. What is meant by Pareto efficiency? What is required
for the economy to be Pareto efficient? If the conditions
of the basic competitive model are satisfied, is the
economy Pareto efficient?
3. What is the difference between partial and general
equilibrium analysis? When is each one especially
appropriate?
4. If the distribution of income in the economy is quite
unequal, is it necessary to impose price controls or
otherwise change prices in the competitive marketplace
to make it more equal?
PROBLEMS
1. Decide whether partial equilibrium analysis would suffice
in each of these cases, or whether it would be wise
to undertake a general equilibrium analysis.
(a) A tax on alcohol
(b) An increase in the Social Security tax
(c) A drought that affects farm production in the
midwestern states
(d) A rise in the price of crude oil
(e) A major airline going out of business
Explain your answers.
2. Explain how each of the following might interfere with
exchange efficiency.
(a) Airlines that limit the number of seats they sell at a
discount price
(b) Doctors who charge poor patients less than rich
patients
(c) Firms that give volume discounts
In each case, what additional trades might be possible?
3. Assume that in the steel industry, given current production
levels and technology, 1 machine costing $10,000
can replace 1 worker. Given current production levels
and technology in the automobile industry, 1 machine
costing $10,000 can replace 2 workers. Is this economy
Pareto efficient; that is, is it on its production possibilities
curve? If not, explain how total output of both
REVIEW AND PRACTICE ∂ 235