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2. rational decision-making by individuals 3. rational individuals preferences can be meaningfully aggregated in some manner to make social decisions about resource allocation in society
Judgements about the distribution of income and wealth are largely implicit in CBA Implicitly, the desired income distribution is the one prevailing at the time of CBA Because money valuations reflect willingness to pay But willingness to pay as reflected by market behavior is a function of ability to pay
PARETO OPTIMALITY
Paretian System
Two fundamental components of Paretian value system 1. Individual preferences count 2. Prevailing income distribution is desireable
PARETO OPTIMALITY
Pareto Criterion
Purpose
Pareto criterion is a technique for comparing or ranking alternative states of the economy
PARETO OPTIMALITY
Pareto Criterion
Pareto Improvement
A movement from state A to state B
PARETO OPTIMALITY
Pareto Optimum
A state of the economy from which it is impossible to make one person better off without making another person worse off. If society finds itself in a position from which there is no Pareto improvement, then there is a Pareto optimum If economy is not in Pareto optimum, some inefficiency in the economy
PARETO OPTIMALITY
Weak Pareto Criterion
Everyone is made better off.
Pareto criterion breaks down if even one individual is made worse off.
PARETO OPTIMALITY
Graphically
Utility Person B Set of Pareto improvements
Utility Possibility Curve Corresponds to all possible combinations of utility for individuals A and B for given production possiblity frontier Utility Person A
3. Favors status quo 4. Not all first-best Pareto-optimal choices are superior to some second-best (Paretoinefficient) choices
Second-best may have superior income distribution
Purpose of potential compensation is to separate efficiency and equity components of a policy change under consideration