ECS3704
NOTES
, ECS3704 Public Economics
Study Unit 1
6 Assumptions of benchmark model
→ Two individuals, both are suppliers of fixed quantities of capital and labour, producers of 2
commodities and consumers of 2 commodities.
→ Fixed tastes and no external effects on consumption. (Indifference curves are continuous, convex,
non-intersecting, diminishing MRS)
→ Unlimited factor substitutions. (Isoquants are diminishing MRTS, constant returns to scale)
→ Consumers maximise utility, and producers maximisers profit, both have prefect knowledge, and
are fully mobile.
→ Competitive commodity and factor markets. (price takers)
→ Assumptions together ensure existence, uniqueness sand stability of a general equilibrium.
The benchmark model and allocative efficiency
→ Allocative efficiency: limited resource of country are allocated in accordance with the wishes of its
consumers.
→ An interaction between consumption activities of individuals and the production activities of
producers.
3 Conditions:
→ Condition 1 - Equilibrium in production
→ Production activities must be Pareto optimal. Not possible to increase output any one commodity
without decreasing the output of at least one other commodity.
1
NOTES
, ECS3704 Public Economics
Study Unit 1
6 Assumptions of benchmark model
→ Two individuals, both are suppliers of fixed quantities of capital and labour, producers of 2
commodities and consumers of 2 commodities.
→ Fixed tastes and no external effects on consumption. (Indifference curves are continuous, convex,
non-intersecting, diminishing MRS)
→ Unlimited factor substitutions. (Isoquants are diminishing MRTS, constant returns to scale)
→ Consumers maximise utility, and producers maximisers profit, both have prefect knowledge, and
are fully mobile.
→ Competitive commodity and factor markets. (price takers)
→ Assumptions together ensure existence, uniqueness sand stability of a general equilibrium.
The benchmark model and allocative efficiency
→ Allocative efficiency: limited resource of country are allocated in accordance with the wishes of its
consumers.
→ An interaction between consumption activities of individuals and the production activities of
producers.
3 Conditions:
→ Condition 1 - Equilibrium in production
→ Production activities must be Pareto optimal. Not possible to increase output any one commodity
without decreasing the output of at least one other commodity.
1
