Social Welfare Practice Problems

While you wont need to hand these problems in, there will be a short, in-class quiz based on these problems or problems very similar to them. You can find a partial answer key posted on the course webpage. 1) Suppose Adam and Eve have identical utility functions as described in the following table: Number of Apples 0 1 2 3 4 5 6 7 8 9 10 Marginal Utility ---10 9 8 7 6 5 4 3 2 1 Total Utility 0 10 19 27 34 40 45 49 52 54 55

When answering these questions, you may find it helpful to carefully draw utility possibility frontier and social indifference curves. A) Suppose the economy can only produce ten apples. Sketch the utility possibility frontier, putting Adams utility on the horizontal axis and Eves on the vertical. B) If you take a utilitarian view (i.e., SW = UA + UE), which allocation of apples maximizes social welfare? C) If you take a Rawlsian view (i.e., SW = min{UA, UE}), which allocation of apples maximizes social welfare? D) Assume Adam is initially endowed with two apples, while Eve is endowed with the remaining eight. Further, assume that for every two apples taken away from Eve, Adam only gets one (the other being lost in the redistribution process). Mark the initial endowment point on your UPF diagram from Problem 1, and on the same diagram draw the new UPF. Allowing for redistribution, which allocation maximizes welfare under a utilitarian social welfare function? Which maximizes welfare under a Rawlsian social welfare function?

2) Suppose Bonnie and Clyde make up a two-person economy where the only two goods consumed are bullets and whiskey. Bonnie and Clydes preferences and the allocation of the two goods are as you see here: 0Clyde A

A) Shade in the combinations of bullets and whiskey that would leave both Bonnie and Clyde at least as well off as they are at the initial allocation (point A). B) Draw a new allocation that would leave Bonnie as well off as she can possibly be without making Clyde any worse off. Label this point B. Draw new indifference curves for Bonnie and/or Clyde as necessary. C) Draw a new allocation that would leave Clyde as well off as he can possibly be without making Bonnie any worse off. Label this point C. Draw new indifference curves for Bonnie and/or Clyde as necessary. D) Draw a contract curve showing all of the allocations of bullets and whiskey that would represent Pareto improvements over point A. [Hint: Points B and C will play an important role here.] E) Suppose Bonnies MRS at point A is 10, while Clydes is 1/10. Give a numerical example of whiskey-and-bullets exchange that would make both Bonnie and Clyde better off. Briefly describe the intuition behind your answer.

Whiskey

ICClyde

ICBonnie

0Bonnie

Bullets

4) Now imagine that Bonnie and Clyde are part of a production economy (i.e., theyre not limited to simply trading a fixed number of bullets and bottles of whiskey but can choose to produce more or less or either good. Explain why point D isnt Pareto optimal if MRSBonnie = MRSClyde = 2 while the marginal rate of transformation (MRT) at point 0Clyde is 1/2. Whiskey 0Clyde

D ICBonnie ICClyde

PPF |slope| = MRT

0Bonnie

Bullets