Scribd
Upload
76 views

Locally Nonsatiated. If (X y P) Is A Walrasian Equilibrium, For Some

The First Fundamental Theorem of Welfare Economics states that if the conditions of a Walrasian equilibrium are met, including locally nonsatiated preferences, then the resulting allocation of goods and services will be Pareto optimal. A Walrasian equilibrium exists when supply equals demand for all goods at a set of market-clearing prices, individuals maximize utility given prices and budgets, and firms maximize profits. If another allocation was Pareto preferred, meaning it made at least one person better off without harming anyone else, it would violate the conditions of the Walrasian equilibrium. Therefore, the allocation from the Walrasian equilibrium must be Pareto optimal.

Uploaded by

Adnan Mohsin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
76 views

Locally Nonsatiated. If (X y P) Is A Walrasian Equilibrium, For Some

The First Fundamental Theorem of Welfare Economics states that if the conditions of a Walrasian equilibrium are met, including locally nonsatiated preferences, then the resulting allocation of goods and services will be Pareto optimal. A Walrasian equilibrium exists when supply equals demand for all goods at a set of market-clearing prices, individuals maximize utility given prices and budgets, and firms maximize profits. If another allocation was Pareto preferred, meaning it made at least one person better off without harming anyone else, it would violate the conditions of the Walrasian equilibrium. Therefore, the allocation from the Walrasian equilibrium must be Pareto optimal.

Uploaded by

Adnan Mohsin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

First Fundamental Theorem of Welfare Economics

Theorem : Assume that all peoples preferences are locally


nonsatiated. If (x , y , p) is a Walrasian equilibrium, for some
distribution of endowments i (i = 1, 2, . . . , I) and distribution of
firm ownership ij (i = 1, 2, . . . , I; j = 1, 2, . . . , J), then the
allocation (x , y ) is Pareto optimal.
locally nonsatiated : the preference relation i on the
consumption set Xi is locally nonsatiated if for any x Xi and
any (Euclidean) distance  > 0 (however small), there is some
other consumption bundle x0 which is within distance  of x,
such that x0 i x
so local nonsatiation is weaker than strict monotonicity ; if i is
strictly monotonic, then x0 = x + (, , . . . , ) must be strictly
preferred to x

counterexamples to local nonsatiation : bliss point, thick


indifference curves

Proof of the Theorem


Suppose that (x , y , p) is a Walrasian equilibrium.
Now suppose that there is some other feasible allocation
(x0 , y0 ) which is Paretopreferred that is such that
(a) x0 i i xi for all i = 1, 2, . . . , I
and
0
(b) x h h xh for some person h
we must show this cant happen

(a) because each


person i chose bundle xi at prices p [with
P
income p i + Jj=1 ij (p yj )], it must be true that
0

p x i p xi
0

[This is where local nonsatiation comes in : if p x i < p xi ,


00
0
then there would be some other x i near x i which would be
both (i) strictly preferred to xi and (ii) inside person is budget
set, violating the fact that xi is person is mostpreferred
choice in her budget set.]
0

(b) because person h prefers x h strictly to xh , it must be true


that
0

p x h > p xh
0

[Otherwise person h would have chosen the (affordable) x h


instead of xh .]

(c) because yj was chosen by firm j to maximize its profits at


prices p, it must be true that
0

p yj p y j
(d) each person must be on her budget set [nonsatiation
again], so that
i

px =p +

J
X

ij (p yj )

j=1

(e) because

i = and
I
X
i=1

ij = 1, part (d) implies that

px =p+

J
X
j=1

p yj

(f ) from (c) and (e),


I
X

px p+

i=1

J
X

pyj

j=1

(g) from (a) and (b), plugged into (f ),


I
X

pxi >p+

i=1

J
X

pyj

(1)

j=1

Equation (1) shows that, as required, the Paretopreferred


allocation (x0 , y0 ) is not feasible. The requirement for feasibility
is
I
X
i=1

xi +

J
X

yj

(2)

j=1

and equations (1) and (2) cannot both hold when p 0 QED

You might also like