Question

Question 2

(a) 20 marks Outline and explain two basic motivations for government intervention in the economy.

(b) Illustrate and explain how the two fundamental theorems of welfare economics describe the relationship between competitive markets and Pareto efficiency.

(c) Explain the equity-efficiency trade-off in economics.

Answer 1

1. In a freely competitive market, there is no government intervention. Everything is fine by the market mechanism. They adopted leissez fair policy. The two motivations for the government to intervene in the market is

* to maximise social welfare

It is the most important goal of the government. In order to maximise social welfare, government tries to regulate concentration of wealth and power in the hands of the people. And make sure the availability of greatest good for greatest number.

* To ensure efficiency, national unity and provide basic infrastructure etc are the other motives of the government . The ultimate objective of the government is to maximise social welfare rather than profit like private firms. They may also intervene to promote general economic fairness ( equitable distribution).

2.There are two fundamental theories of welfare economics

1. Competitive equilibrium leads to Pareto efficient allocation or distrumibution of resources. Pareto efficiency explains with the assumption that there is perfectly competitive market. Where an invisible hand will clear any disequilibrium formed by the demand and supply. Pareto efficiency or optimal point means it is impossible to make my one better off without taking some one worse off.

MRSxy A =MRS xy B = MRPT

all Pareto points are not efficient point.. Any point on the contract curve is the Pareto efficient point. Here market do the work and the final outcome will be the Pareto efficiency

2. Second theorem explains the opposite of first theorem that efficient allocation can be maintained by a competitive market or competitive equilibrium. Here fairness depends on the market mechanism with lum sum transfer payments by the government which leads to the desired level of output distribution in the society.

3. Equity efficiency trade off in economics

Human wants are unlimited but resources are scare or limited. So we need to decide our priorities and distribute resources among them. Here we take in to account the gold of efficiency and equity. Efficiency means an increase in economic resources whereas equity is the fair distribution of that resources. In the case of distribution of resources we will face a trade of between efficiency and equity. This can be explained with the help of am example

A development will make gain to some people( gainers) and make losses to some local people who might be living there from their ancestors(losers). It creates a trade off between equity and efficiency. In order to implement this development programme the beneficiaries must pay a compensation to its losers. One can gain only at the expense of the other.

Some times both efficiency and equity go hand in hand. Especially in the case of social capital like health and education to the poor sections of the society.

Here we can conclude that some times equity will compromise for efficiency and efficiency will compromise for equity like siblings.