## Question from Past Microeconomics Qualifying ExamEdit

**Fall 2004 - Section I, Question one, George Mason University**

T, F, U. State first whether the following statements are true, false or uncertain. Then briefly explain your reasoning in four or five sentences. You may use a graph if it helps clarify your answer.

The first Welfare Theorem holds that a market equilibrium is Pareto efficient. An implication is that market equilibrium is also Kaldor-Hicks efficient. Include a brief definition of Pareto vs. Kaldor-Hicks efficiency.

## AnswerEdit

False.

A situation is Pareto efficient if no one person can be made better off without making another person worse off. A Pareto improvement will make someone better off without making anyone else worse off.

A situation is Kaldor-Hicks efficient if it is socially optimal. A Kaldor-Hicks improvement is any increase in social benefit independent of its implications for the individual.

Every Pareto improvement is also a Kaldor-Hicks improvement, but almost no Kaldor-Hicks improvement is a Pareto improvement. A situation that is Kaldor-Hicks efficient is also Pareto efficient, but a Pareto efficient situation is most of the time not Kaldor-Hicks efficient.

Market equilibria are mostly Pareto efficient, because the market guarantees that resources are put to their highest valued use. However, most market equilibria could be Kaldor-Hicks improved through redistribution.

### From Caplan's notesEdit

Assumption 1: Ui(p) has a unique solution for all i and all p.

Assumption 2: Total demand for good k exceeds total endowment for a small enough pk, and falls short of total endowment for a large enough pk.

Assumption 3: The total demand function for k is continuous in pk for 0<pk<1.

- First Welfare Theorem: Under the previous assumptions, the general equilibrium allocation is Pareto efficient.

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