CHAPTER 5

NORMATIVE OR WELFARE ECONOMICS, DECISIONS AND GAMES, AND BEHAVIORAL ECONOMICS

5.1 INTRODUCTION

Our efforts thus far have been primarily devoted to perfect competition. When perfect competition conditions exist, it turns out that no individual consumer or firm can increase their objective function or payoff without decreasing the payoff for other firms and/or consumers. When imperfect competition (externalities, public goods, taxes and subsidies to selected firms or consumers, and other conditions) exist, the rules of perfect competition do not generally apply. Improvements in the accuracy of the results obtained by assuming perfect competition are then often possible, as well as improvements (or at least changes) in the results that accrue to firms and consumers. In this chapter we will examine concepts of optimality and economic efficiency of production and distribution under such conditions. We will focus on the allocation of land, capital, and resources in ways that generate the maximum benefit to society (or the community or nation). There are two fundamental issues underlying this: the allocation of the factors of production and the distribution of these products among different individuals. We will examine efficient, effective, and equitable ways in which we can accomplish this allocation. Then we will discuss the concept of social welfare and the conditions that must exist to determine optimum behavior under these social welfare conditions. This will lead us in ...

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