Question

1.The concept of Pareto efficiency is not controversial and is a useful tool to evaluate tax policies. Explain the idea of Pareto efficiency and whether or not you agree with this statement.

2.Terry will trade four pizzas for one six-pack of beer and be equally happy. At the same time, Dean will gladly exchange two of his six-packs for six pizzas. Is the allocation of beer and pizza Pareto efficient? Explain and provide a diagram.

Answer 1

1. Yes, I agree that the concept of Pareto efficiency is useful in designing policies especially tax where the government should seek better off situation for everyone with out making anyone worse.

The Pareto efficiency concept is about reaching the optimal utility state after which any reallocation of resource might have positive effect on one i.e. increase in one's utility but it would also decrease someelse's utility. Finding a point where exchange of utility with a product is possible between individual, they all would lie on Pareto efficiency line, As we can see in below graph if the trade between the goods and same utility exchange, they all would lie on pareto efficiency graph like point A and B.

2. Lets say in given example Terry has same utility for 4 Pizzas and One six pack beer. (4:1)

and Dean has same utility for 6 Pizzas and 2 six pack beer (6:2)

Here we can see that if they exchange beer and pizzas with each other Dean can take 3 pizzas in for a six pack beer and Terry would be happy to give even 4 pizzas for same one six pack beer, Similarily Dean would be happy to give one six pack beer for 3 pizza. Therefore if the exchange takes place there would be someone here who is getting better off without impacting the other person, Dean (getting 4 Pizzas for same one pack of beer), Terry (getting a six pack beer with less pizzas). Here both of them can be better off with out making the other person worse off, therefore the alloction is not Pareto Efficient.