India Economic Survey Complete for the year of 2022 to 2023
Topic 3 - efficiency
1. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
Ici,
on
a
les
3
courbes
d’indifférences
d’Alice.
Où
que
l’on
se
trouve
sur
la
courbe
d’indifférence,
on
tirera
la
même
satisfaction,
qu’on
ait
plus
10
de
food
et
5
de
drink
ou
5
de
food
et
10
de
drink
par
exemple.
Ici,
on
voit
qu’il
y
a
plusieurs
courbes
d’indifférence.
L’humain
préfèrera
toujours
avoir
+,
donc
plus
la
courbe
de
satisfaction
sur
laquelle
on
se
trouve
est
élevée,
plus
la
satisfaction
de
l’humain
(Alice
ici)
sera
élevée.
1
Part
II:
Efficiency
and
market
failures
Topic
3
–
Efficiency
“All
in
all,
climate
change
must
be
regarded
as
market
failure
on
the
greatest
scale
the
world
has
seen”
N.
Stern
(2006)
The
market
efficiency
can
face
4
types
of
issues:
1. No
perfect
competition:
when
we
have
monopolies,
oligopolies,
etc.
there’s
no
efficient
outcome
possible
2. Asymmetries
of
information1
3. Public
goods
and
externalities
1. Introduction
v Market
and
the
role
of
governments
v Main
issue:
do
markets
perform
well?
v Goal:
have
a
general
framework
to
organise
thoughs
about
the
desirability
of
various
governmental
actions
v Welfare
economics
framework:
branch
of
economic
theory
concerned
with
the
social
desirability
of
alternative
economic
states
2. The
concept
of
efficiency
Rappel:
les
courbes
d’indifférence:
NB
:
On
parle
de
courbes
d’indifférence
et
de
boite
d’Edgeworth
dans
l’hypothèse
d’une
économie
sans
production,
une
économie
d’échange.
1
On
parle
d’asymétrie
de
l’information
en
économie
quand
lors
d’un
échange,
certains
participants
ont
des
informations
pertinentes
dont
les
autres
ne
disposent
pas.
2. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
2
La
boite
d’Edgeworth
Robinson
et
Vendredi
vont
donc
échanger
jusqu’à
ce
qu’il
n’y
ait
plus
d’échanges
mutuels
avantageux
possibles.
Une
fois
arrivés
à
ces
points,
on
atteint
des
«
optimum
de
Pareto
»,
ils
se
situent
au
croisement
des
courbes
d’indifférence
des
deux
individus.
Concept
of
efficiency
Pareto
Improvement
=
Reallocation
of
resources
that
makes
at
least
one
person
better
off
without
making
anyone
else
worse
off.
Ici
on
a
les
courbes
d’indifférence
de
Robinson,
et
celles
de
Vendredi
représentées
dans
l’autre
sens.
Les
deux
vont
vouloir
maximiser
leur
satisfaction
et
donc
se
retrouver
sur
la
courbe
d’indifférence
la
plus
élevée
possible.
Plus
on
va
vers
le
coin
en
haut
à
droite,
plus
la
satisfaction
de
Robinson
augmente,
et
plus
on
va
vers
le
coin
en
bas
à
droite,
plus
la
satisfaction
de
Vendredi
augmente
Making
Bob
better
off
while
not
making
Alice
worse
off
Making
Alice
better
off
while
not
making
Bob
worse
off
3. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
If
we
let
the
market
go,
we
can
move
to
another
location
that
will
improve
the
situation
of
at
least
one
actor
without
deteriorating
the
situation
of
another
one
3
Pareto
efficient
allocation
=
allocation
such
that
no
person
can
be
made
better
off
without
making
another
person
worse
off.
In
case
of
efficient
allocations,
there
are
no
wasted
resources.
(See
appendix
for
more
information)
As
we
can
see
it
above,
the
condition
for
Pareto
efficiency
is
to
have
indifference
curves
that
are
tangent.
Thus
MRSAD,F
=
MRSBD,F
è(MRSAliceDrink,Food
=
MRSBobDrink,Food)
è
Intuition
(example):
when
MRS
differ
across
individuals,
there’s
an
incentive
to
trade.
Marginal
Rate
of
Substitution
(MRS)
=
the
rate
at
which
the
individual
is
willing
to
trade
one
good
for
an
additional
amount
of
another.
è
Le
taux
marginal
de
substitution
c’est
le
nombre
de
biens
«
food
»
qu’un
individu
est
prêt
à
céder
en
échange
d’une
unité
supplémentaire
de
biens
«
drink
»
(ou
l’inverse),
cela
peut
aussi
être
la
quantité
minimale
de
bien
«
food
»
que
l’individu
exige
pour
céder
un
bien
«
drink
»
(ou
l’inverse).
è
this
it
the
concept
of
Pareto
Efficiency
4. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
4
Economy
with
production
We
have
to
decide
how
we
organize
the
production.
We
can
decide
between
producing
more
food
and
less
drink,
or
producing
more
drink
and
less
food.
We
have
to
reach
efficiency
in
production,
not
only
in
consumption.
In
our
economy,
it’s
the
same:
we
have
to
decide
whether
we
should
produce
more
medical
services
and
fewer
cars
for
example.
If
we
could
do
better
for
some
people
without
doing
worse
for
other
people,
it
would
mean
we
might
organize
our
economy
in
that
way
and
reach
a
situation
that
would
be
more
efficient.
Marginal
Rate
of
Transformation
=
the
rate
at
which
the
economy
can
transform
one
good
into
another
one
(slope
of
the
production
possibilities
curves).
Condition
for
efficiency
within
production:
MRTD,F
=
MRSAD,F
=
MRSBD,F
è
without
this
equality,
we
don’t
have
efficiency.
If
the
society
is
not
organized
in
a
good
way,
it
means
there’s
room
for
changes
that
could
make
it
more
efficient.
As
a
condition
for
efficiency,
the
slope
between
2
goods
(food
and
drink)
should
be
equal
to
the
marginal
rate
of
substitution
of
the
different
customers.
è
Intuition:
Up
to
now,
we
just
talked
about
allocations
of
resources.
How
to
organise
a
society
so
as
to
reach
a
Pareto
efficient
allocation?
And
do
market
economies
lead
to
Pareto
efficient
allocation?
5. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
5
3. The
first
fundamental
theorem
of
welfare
economics
The
first
fundamental
theorem
of
welfare
economics:
“as
long
as
producers
and
consumers
act
as
perfect
competitors,
that
is,
take
prices
as
given,
then
under
certain
conditions
(see
later)
a
Pareto
efficient
allocation
of
resources
emerges”
Key
role
of
prices:
Actor
Consumers
푀푅푆!,! =
푃!
푃!
• PD
=
Price
of
D
• PF
=
Price
of
F
Producers
푀퐶! = 푃!
푎푛푑 푀퐶! = 푃!
푃!
푃!
=
푀퐶!
푀퐶!
= 푀푅푇!,!
THUS
푀푅푆!,! = 푀푅푇!,!
è
Condition
for
efficiency
è
If
you
let
people
do
what
they
want
to
do,
you’ll
have
an
enforcement
of
property
rights,
and
then
you
let
the
market
go.
You’ll
have
an
organization
of
the
society
that
will
be
efficient,
meaning
that
we
won’t
be
able
to
improve
the
satisfaction
of
some
users
without
diminishing
the
one
of
others.
BUT,
therefore,
we
need
some
conditions
to
be
fulfilled:
we
need
perfect
competitions
+
other
conditions
(see
later).
Those
conditions
are
not
actually
met.
This
takes
place
through
the
crises
of
resources,
of
the
goods
we
sell.
The
prices
are
giving
signals
and
are
orienting
the
economy:
supply/demand
law.
è
If
the
supply
is
lower
and
the
demand
is
higher,
the
price
will
rise.
It
means
that
only
the
people
valuing
the
price
of
the
good
really
high
are
going
to
pay
for
this
good.
This
is
done
in
order
to
avoid
wasting
resources
(efficiency).
In
a
nutshell,
a
competitive
economy
(decentralisation,
Adam
Smith
‘invisible
hand’)
leads
to
efficiency,
and
that’s
really
powerful.
There’s
a
key
role
of
prices.
There’s
a
role
for
a
government:
even
under
perfect
competition
and
when
there
are
“certain
conditions”
that
are
met,
there’s
a
role
for
a
government:
• Protect
property
rights
so
that
markets
can
work
(ex:
justice),
that
the
minimal
role
of
a
government
• Deal
with
fairness/equity
4. The
role
of
fairness/equity
Among
Pareto
efficient
(PE)
allocations,
which
one?
(see
Edgeworth
box)
Observation:
a
non-‐Pareto
Efficient
allocation
(ex:
y
that’s
not
on
the
contract
curve)
might
be
preferred
to
a
Pareto
Efficient
allocation
(ex:
x
or
z
that
are
on
the
contract
curve)
from
the
society’s
point
of
view.
6. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
Here,
we
might
think
an
allocation
such
as
y
is
not
efficient,
because
it’s
not
on
the
contract
curve,
but
actually,
it
is
efficient
(same
for
x
and
z
that
are
on
the
contract
curve).
The
contract
curve
=
the
maximum
utility
we
can
give
to
Alice
or
Bob
How
do
you
compare
the
utilities
of
different
persons?
It’s
a
tricky
question.
We’ll
look
at
the
social
indifference
curves
(SIC).
If
we
have
the
utility
of
A
and
B,
we
have
the
same
satisfaction,
so
the
same
W.
Each
curve
is
a
social
difference
curve
and
The
map
=
the
social
indifference
curves
6
Tools:
Utility
possibilities
curves
(UPC)
and
social
indifference
curves
(social
welfare
functions).
Social
indifference
curves
(SIC)
and
Here
we
see
the
utility
possibilities
curves:
• The
utility
is
maximal
for
Alice
if
you
give
everything
to
Alice
• The
utility
is
maximal
for
Bob
if
you
give
Bob
everything
social
welfare
functions
(SWF):
푊 = 푓 푈!"#$%,푈!"#
푤푖푡ℎ 푈!"#$% 퐹,퐷 푎푛푑 푈!"#(퐹,퐷)
Social
welfare
framework
=
social
welfare
functions:
you
have
to
decide
for
everyone.
If
you
look
at
people
in
terms
of
their
utilities,
you
have
to
take
some
decisions
to
allocate
the
resources,
then
you
have
to
aggregate
so
you
have
the
utilities
of
everyone.
Satisfaction
can
come
from
the
fact
you’re
wearing
nice
clothes,
driving
a
nice
car
etc.
but
it
could
also
come
from
the
fact
you
look
at
nice
landscapes,
etc.
7. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
Here,
you
look
at
the
utility
of
everyone
(the
utility
of
Bob
and
the
utility
of
Alice)
and
then
you
try
to
find
one
number:
W.
This
number
will
depend
on
what
you
put
in
the
utilities
of
Bob
and
Alice
(cars,
etc.).
Then
you
can
decide
to
do
something
else:
You
could
decide
you’d
like
people
to
be
more
taking
care
of
older
people,
etc.
7
è
you
search
for
the
greatest/highest
W.
More
on
social
welfare
functions:
two
extreme
cases
♥ Utilitarianism:
W
=
U1
+
U2
+
…
+
UN
♥ Maximin
criterion:
W
=
min
(U1
+
U2
+
…
+
UN)
Half-‐half
B
has
some
utility
and
A
has
none:
A
is
starving
Le
maximin
=
maximiser
le
sort
de
la
catégorie
la
plus
défavorisée,
le
sort
de
ceux
qui
ont
le
moins.
Level
of
utility:
Here
we
could
decide
to
give
all
the
utility
to
A
or
all
the
utility
to
B,
or
to
be
just
in
the
middle:
half-‐half
Here
we
take
the
minimum
within
all
the
utilities
of
all
the
people
(John
Rawls):
We
look
at
the
poorest
person.
If
we
want
to
raise
the
social
welfare,
we
have
to
raise
the
satisfaction
of
the
poorest
person,
so
we
have
to
allocate
more
resources
to
the
poor
people.
8. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
8
Choice
of
the
fair
(and
efficient)
allocation:
5. The
second
fundamental
theorem
of
welfare
economics
The
second
fundamental
theorem
of
welfare
economics:
“Any
Pareto
efficient
allocation
can
be
attained
by
making
a
suitable
assignment
of
initial
endowments2
and
letting
people
trade
with
each
other”.
Hence,
interventions
on
market
themselves
is
not
necessary,
redistributing
income
is
enough.
Initial
endowment:
If
we
start
from
such
an
allocation
and
let
the
market
work,
Alice
will
give
some
of
her
drinks
to
Bob,
in
exchange
with
Bob’s
food,
so
Alice
will
have
fewer
drinks
and
more
food,
and
Bob
will
have
more
drinks
and
less
food
than
at
the
beginning.
Here
we
let
the
market
work,
we
just
have
to
redistribute
endowments.
The
government
redistributes
income
mainly
through
thanks
to
taxes:
they
redistribute
through
the
tax
system.
2
Dotation
initiale
If
I’m
a
social
planner,
I
will
look
at
all
these
curves
and
chose
the
level
at
which
the
utility
is
the
highest.
Here
we
have:
♥ The
utility
possibilities
curve
♥ The
indifference
curves
The
point
where
curves
meet
is
more
efficient
that
the
rest
of
the
utilities
curves.
This
is
the
point
where
this
is
the
best
at
the
society
point
of
view.
9. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
Redistribution
of
initial
endowments
9
GDP
=
Gross
Domestic
Product
=
what
is
produced
in
a
year.
Half
of
the
GDP
is
subject
to
taxes.
The
government
has
the
power
to
take
half
of
the
GDP
and
to
redistribute
it
through
various
allocations
(example:
the
fact
that
education
is
free
until
18
years
old,
etc.).
We
really
benefit
from
the
money
redistribution.
The
public
intervention
is
really
significant
and
powerful
è
the
government
taxes
income,
with
higher
taxes
for
people
with
higher
revenues.
The
taxes
are
not
proportional
taxes
but
progressive
taxes:
if
we
have
an
income
of
10,
we
will
pay
1
of
taxes,
but
if
we
have
an
income
of
100,
we
will
pay
more
than
10
of
taxes.
Equity-‐Efficiency
trade-‐off
Problem:
government
needs
some
way
to
reallocate
resources
and
those
mechanisms
usually
induce
inefficiencies
(e.g.
income
tax)
Thus,
in
practice,
there
is
to
some
extent
a
trade-‐off
between
efficiency
and
equity.
The
3
main
ways
to
collect
money
=
♥ VAT
♥ Tax
income
♥ …
When
we
use
tax
income
to
collect
money,
people
that
are
working
know
they
will
have
much
less
than
what
they
have
truly
earned
while
working.
It
does
not
encourage
them
to
work
much.
It’s
the
same
for
VAT,
if
someone
likes
something,
the
fact
he
has
to
pay
VAT
when
he
buys
it
is
a
disincentive
event.
The
government
has
to
find
a
way
to
deal
with
that
problem
of
disincentive
events.
è
When
we
have
a
tax
system,
we
need
to
create
efficiency
because
the
tax
system
creates
a
disincentive.
If
we
want
to
move
from
an
allocation
we
think
is
not
fair
because
Alice
has
everything
and
Bob
has
nothing,
if
we
do
not
move
ON
the
curve,
we
lose
some
efficiency.
10. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
10
Excess
burden
of
taxation:
the
window
tax
example
1696-‐1851:
“when
the
window
tax
was
introduced,
it
consisted
of
2
parts:
• A
flat-‐rate
house
tax
of
2
shillings
per
house
and
• A
variable
tax
for
the
number
of
windows
above
ten
windows.
Properties
with
between
ten
and
twenty
windows
paid
a
total
of
four
shillings,
and
those
above
twenty
windows
paid
eight
shillings”.
è
Depending
on
the
number
of
windows
we
had
on
our
house,
we
had
to
pay
more
or
less
taxes.
This
could
create
a
disincentive
to
having
windows.
This
was
not
the
purpose
of
having
such
a
taxation
system.
6. Conditions
under
which
markets
do
not
lead
to
efficiency
Back
to
the
first
fundamental
theorem
of
welfare
economics:
possible
market
failures.
• Imperfect
competition:
Imperfect
competition
arises
when
agents
have
the
ability
to
influence
the
price
of
a
commodity
(monopoly,
oligopoly,
product
differentiation,
etc.)
It
leads
to
prices
above
marginal
costs
or
above
marginal
productivity.
Conditions
for
efficiency
are
violated.
For
example,
in
the
case
of
monopolies,
prices
are
above
the
marginal
cost:
it
means
companies
are
capturing
rents,
they
could
produce
more,
so
it’s
not
efficient.
Ex:
the
electricity
market:
there
are
some
measures
taken
on
the
concentration
of
producers,
it
has
an
impact
on
the
price.
• Asymmetric
information:
Asymmetric
information
is
present
when
a
party
engaged
in
an
economic
transaction
has
better
information
about
the
good
and
service
traded
than
the
other
party.
Ex:
insurance
against
the
possibility
of
becoming
poor.
Everyone
doesn’t
know
the
same
things.
Ex:
social
security
-‐
example
of
a
public
intervention:
there’s
asymmetric
intervention.
In
Europe,
we
have
a
social
security
system
very
well
developed
compared
to
other
countries.
Many
people
will
have
the
possibility
to
be
insured
(private
insurance);
however,
many
people
don’t
have
the
possibility
to
be
insured
because
they
are
too
poor
and,
moreover,
it’s
not
efficient,
it
is
not
covering
all
the
sorts
of
disease.
There’s
asymmetric
information
between
the
doctor
and
the
patient
for
example.
• Public
Good:
A
public
good
is
a
good
that
is
non-‐rival
and
non-‐excludable
in
consumption,
for
example
the
roads.
è
Un
bien
public
est
un
bien
que
chacun
peut
consommer
en
même
temps,
en
même
quantité
et
dans
sa
totalité.
On
ne
peut
pas
exclure
quelqu’un
de
l’accès
à
ce
bien
(non-‐
excludable),
si
quelqu’un
utilise
ce
bien,
cela
n’empêche
personne
de
l’utiliser
aussi
(non-‐rival),
et
au
niveau
de
la
production,
le
cout
marginal
=
0,
cela
veut
dire
que
pour
une
personne
supplémentaire
utilisant
ce
bien,
le
cout
est
nul,
cela
ne
change
rien
qu’une
personne
en
plus
utilise
la
route
par
exemple.
• Externalities:
An
externality
is
an
activity
of
one
entity
that
affects
the
welfare
of
another
entity
in
a
way
that
is
outside
the
market.
Ex:
airplane
noise
pollution.
11. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
On
parle
d’externalités
dans
une
situation
économique
ou
l’acte
d’un
agent
influe
positivement
(externalités
positives)
ou
négativement
(externalités
négatives)
sur
la
situation
d’un
autre
agent
non-‐impliqué
dans
l’action,
sans
que
ce
dernier
ne
soit
totalement
compensé
ou
n’ait
à
payer
pour
les
dommages
et
bénéfices
engendrés.
Exemple
d’externalités
négatives
:
la
pollution
Public
goods
and
externalities
are
dealing
with
the
existence
of
public
goods
and
the
fact
that
we
have
externalities.
When
there
are
public
goods,
the
market
will
never
be
efficient.
NB:
in
asymmetric
information,
public
good
and
externalities,
markets
are
missing.
11
7. Conclusion
Two
criteria
to
evaluate
the
state
of
an
economy
(an
allocation
of
resources):
• Efficiency
(Pareto
efficiency):
no
waste
• Equity/fairness:
social
welfare
function
approach
“Role”
of
markets:
Competitive
markets
lead
to
efficiency
when
there
is
a
market
for
each
and
every
commodity
(i.e.
no
imperfect
competition,
no
public
goods,
no
externalities).
Role
of
a
government:
• Enhance
efficiency:
deal
with
market
failures
(imperfect
competition
and
missing
markets)
and
minimal
role
of
property
right
protection
• Enhance
equity:
deal
with
distributional
issues
Possible
trade-‐off
between
efficiency
and
equity.
Appendix
1:
a
note
on
social
choice
How
do
we,
as
society,
choose
a
(desired)
point
along
the
UPF3?
We
need
a
“social
choice
function
(SCF)”,
an
ordinal
ranking
of
the
alternatives.
• What
criteria
should
such
a
function
have?
• How
do
we
choose
which
function
is
the
right
one?
A
social
planner
is
a
kind
of
cop.
How
do
we
decide
what
to
do?
We
do
vote/elect
politicians.
They
have
programs
regarding
intervention
on
the
market.
They
are
writing
laws
intervening
on
the
economy:
the
allocation
of
resources
includes
fiscal
instruments
è
they
do
define
a
program
with
more
taxes
on
companies,
more
redistributions,
etc.
for
example.
è
The
way
those
things
(programs)
take
place
in
reality
=
through
democracy,
etc.
3
Utility
Possibility
Frontier
12. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
12
Arrow’s
impossibility
theorem
(no
question
at
the
exam)
• Pareto
principle:
“If
at
least
one
individual
prefers
option
x
to
option
y
and
no
one
strictly
prefers
y
to
x
then
society
prefers
x
to
y”
• Universal
domain:
The
SCF
should
work
for
any
set
of
individual
preferences
(no
matter
how
weird).
• Non-‐Dictatorship:
The
SCF
should
not
depend
solely
on
the
rankings
of
one
individual
• Independence
of
irrelevant
alternatives:
The
ranking
of
x
and
y
should
only
depend
on
individual
rankings
of
x
and
y
and
not
on
the
preferences
of
individuals
over
x
and
z
(nor
y
and
z).
Arrow:
Any
SCF
should
be
complete
and
transitive
and
satisfy
these
four
criteria.
However,
no
SCF
can
satisfy
these
four
criteria
Condorcet’s
Paradox
(as
an
illustration
of
Arrow’s
impossibility
theorem)
Rankings
of
alternatives,
example
• Liberals:
Green
Park
>
Public
housing
>
Private
housing
• Labour:
Public
housing
>
Private
Housing
>
Green
Park
• Conservatives:
Private
Housing
>
Green
Park
>
Public
housing
Consider
majority
rule
as
a
“social
choice
function”:
When
considering
two
policies,
select
the
one
that
more
people
prefer.
This
will
satistfy
PUDI.
But
in
the
case
above,
the
choice
will
depend
on
the
way
these
are
paired
(as
in
Rocks-‐
Paper-‐Scissors).
“Society
prefers”
Green
Park
to
Public
housing,
Private
housing
to
a
Green
park,
and
Public
housing
to
Private
housing.
è
Social
preferences
are
not
transitive.
Appendix
2:
Pure
exchange
economy
• 2
goods:
Food
and
Drink
• 2
people:
Alice
and
Bob
Note:
results
hold
for
many
people
and
commodities
è
The
Edgeworth
box:
13. Public
Economics
2013-‐2014
Topic
3:
Efficiency
Manon
Cuylits
Each
point
is
a
basket
of
goods
(food
and
drinks).
13
Alice
Bob
è
Together
A
possible
initial
location
Same
level
of
satisfaction
for
any
basket
on
a
given
indifference
curve.