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Economic Theory State Intervention Notes

Economics Notes > The Economics of Public Expenditure Notes

This is an extract of our Economic Theory State Intervention document, which we sell as part of our The Economics of Public Expenditure Notes collection written by the top tier of University Of Birmingham students.

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Economic Theory: State Intervention A society contains an identity of interests and conflicts of interest between individuals and groups. There are several reasons and justifications for why state intervention occurs. Economic efficiency is about making the best use of limited resources given people's taste - involves the choice of an output bundle. The aim of policy is to maximise social welfare subject to the constraints of tastes (consumer preferences), technology (production is dependent on the production functions) and resources (inputs for production dependent on the availability of capital and labour).

EFFICIENCY IN CONSUMPTION (consumer optimisation) Idea is that no-one can be made better-off without making someone else worse-off. Means consumers should allocate their income in a way that maximises their utility, given their incomes and the prices of the goods they buy. Therefore the marginal rate of substitution must be equal for all individuals. This can be shown by the Edgeworth Box.

* Contract curve shows the combinations of the 2 goods which the MRS for the goods is the same for both individuals.

* Any movement away from the contract curve makes at least one person worse off so any point on it is an efficient allocation. PARETO EFFICIENCY AND THE MARKET Pareto efficiency is the allocation of resources in such a way that no reallocation can make any individual better-off without making at least one other individual worse-off. 1) First Fundamental Theorem - A competitive equilibrium is Pareto Efficient. 2) Second Fundamental Theorem - If preferences and technology are convex, and Pareto Efficient outcome is a competitive equilibrium for some pattern of initial endowments. Pareto improvement is not ideology free as it is based on individuals. We assume social welfare is increased even if only one person is made better off (and nobody is worse-off) and that individuals are the best judges of their own welfare. Focus is on individuals, not any relationships between them. Goals of welfare are efficiency and equity or social justice. So ask:
- Given an initial endowment what is welfare improvement?
- Is the optimal distribution allocatively efficient and socially just?
THEORIES OF SOCIETY All theories of society agree movement to some points on the contract curve is efficient and that no distribution is just unless it is also efficient. There are 3 broad types of theory; Libertarians (natural right, empirical), Liberal theories (Utilitarianism, Rawls theory) and Collectivist theories. LIBERTARIAN VIEWS Ideology of Laissez-faire advocating free markets and private property as they maximise total welfare Leaders were Adam Smith, Mill and Hume. Hayek and Friedman followed after. Natural-Rights Libertarians Nozick (1074) suggested everyone has the right to distribute the rewards of their own labour - justice in holdings. Owners know best what to do with assets. A person is entitled to a holding if it has been acquired through earnings or an inheritance. Everything else the government can redistribute. Supported minimalist/'night-watchman' state provided one public good - defence of person and property. Argued taxation was theft (extracting money earned fairly) and slavery (forcing people to spend time working for the gov).

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