You wake up one morning and find yourself in a room with Ren and Stimpy. You...

You wake up one morning and find yourself in a room with Ren and Stimpy. You are not sure how you got there but that is irrelevant for the problem. Ren and Stimpy each have an allocation of pizza and beer. You obtain the following information through a pleasant, yet somewhat strange, conversation. Ren will trade two pizzas for one six-pack of beer and be equally happy. At the same time, Stimpy will gladly exchange six pizzas for two of his six-packs. Is the allocation of beer and pizza Pareto efficient? Illustrate using an Edgeworth box. If you determine the allocation is not Pareto efficient describe a Pareto improving trade between Ren and Stimpy.

Expert Solution

Answer : According to Pareto efficient condition in exchange MRS _XY for A = MRS_XY for B

Let here X = Pizza ; Y = Beer ; A = Ren ; B = Stumpy.

Where, MRS = Marginal Rate of Substitution = Px/Py

Px = price of commodity X ; Py = Price of commodity Y

But according to the given information, for Ren's trade; 2 Pizzas = 1 six-pack of beer where for Stimpy's trade; 6 Pizzas = 2 six-packs of beer. This means here Pareto optimal allocation in exchange is not possible. Because here both traders conditions are not equal.

Pareto optimal trade is possible between Ren and Stimpy, if Ren increase the exchange rate like 3 Pizzas = 1 six-pack of beer. In this case 6 Pizzas = 2 six-packs of beer is possible. Therefore, here Pareto optimal exchange efficiency is possible.

OR,

If Stimpy reduce his exchange rate like 4 Pizzas = 2 six-packs of beer then Pareto exchange efficiency is possible. Because in this case 2 Pizzas = 1 six-pack of beer is possible.

Thus, Ren and Stimpy can improve their exchange rate to attain the Pareto efficiency in exchange.

Rahul Sunny answered 1 year ago

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