D. The meaning of utility, wealth, and income, and the postulate of maximization
1) Pareto-optimal condition of efficiency
- Pareto condition is the only definition of economic efficiency for a society.
- A society is said to be efficient when the Pareto condition is satisfied.
- Pareto condition is a state where it is not possible to reallocate resources so that one can gain without the loss of another.
- Implications of Pareto condition:
i) An individual cannot say that the society is unambiguously better-off when a reallocation of resources harms at least one person.
ii) If Pareto condition is not attained, it is possible for the economy to have a net-gain in the sense that at least one individual can gain without harming others, through reallocating the resources.
2) Maximization, Economic efficiency and equilibrium
- The postulate of constrained maximization implies that economic efficiency is always achieved by the maximizing individuals because individuals will try all constrained means to exhaust all potential gains.
- Equilibrium
- Equilibrium refers to a state where there is no internal tendency to change.
- When a resource allocation is said to be in equilibrium, there is no tendency for the resources to reallocate if all the constraints remain unchanged.
- Cheung’s interpretation of equilibrium
- Equilibrium exists when the constraints specified in the model can yield testable implications on human behaviour.
- An equilibrium price is said to prevail when there is sufficient information to explain its existence.
- An economic theory is established to explain how individuals react to a change in constraints.
- Every economic theory is implied and constructed by combining the postulate of maximization, the efficiency condition and the concept of equilibrium.
3) The meaning of utility
- Utility is an arbitrary assignment of numbers for ranking options in the interpretation of human choice.
4) The meaning of wealth
- Wealth is the discounted value of all incomes.
5) The meaning of income
- Income is the maximum one can consume without leading a reduction in wealth.
