Question

In: Economics

Assume economy with two goods x and y and two people Alice and Bob. The MRSA...

Assume economy with two goods x and y and two people Alice and Bob. The MRSA of Alice is 15. The MRSB of the Bob is 10.

(a) Is the current allocation of x and y is efficient? Why yes or why not?

(b) Is there a trade that would be voluntary? Explain. Support your answer by graph.

(c) Pareto Efficient Allocations, the Contract Curve and the Core. Define these three terms and explain the relationship between them. Use the graph from previous part.

Solutions

Expert Solution

a.

The current allocation of goods is not efficient. For efficient allocation of goods the marginal rate of substitution between two goods should be equal for all consumers. Here the marginal rate of substitution of Alice is not equal to marginal rate of substitution of Bob .

b.

There can be trade which is voluntary. Both the consumers can be better off with trade.

c.

According to Pareto optimality criterion, any change that makes at least one individual better off is an improvement in social welfare. Here , the movement from point Z to H is an improvement in social welfare.

The points of tangency of two sets of indifference curves forms the contract curve. Here, the contract curve passes through H.

Rahul Sunny answered 2 years ago
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