PUBLIC FINANCE

Project description

1. Answer the following questions regarding Pareto Efficiency:

a. When is an allocation of resources Pareto Efficient?

b. What is the condition of Pareto efficiency in a pure exchange economy? Explain

the economic intuition of it.

c. What is the condition of Pareto efficiency in a production economy? Explain the

economic intuition of it.

d. Is it possible to have a Pareto efficient allocation where someone is worse off than

he is at an allocation that is not Pareto efficient?

e. Is it possible to have a Pareto efficient allocation where everyone is worse off

than they are at an allocation that is not Pareto efficient?

f. Can some individual be made better off if we are at a Pareto efficient allocation?

2. What is a contract curve? Show it with the help of a diagram. If you know the contract

curve, can you tell the outcome of any trading?

3. Is competitive equilibrium a good thing or bad thing for an economy? Give reasons for

your answer.

4. Assume an economy with only one consumer, Robinson Crusoe, and two goods – coconut

and fish. The traditional name for this economic model is the Robinson Crusoe economy,

after Defoes shipwrecked hero. If Robinsons marginal rate of substitution between

coconut and fish is 2 and the marginal rate of transformation between the two goods is

1, what should he do if he wants to increase his utility?

5. Suppose that in the Robinson Crusoe economy, Robinson finds a friend called Friday.

Further suppose that Robinson can produce 10 pounds of fish per hour or 20 pounds of

coconuts per hour and Friday can produce 20 pounds of fish per hour or 10 pounds of

coconuts per hour. Robinson and Friday both want 60 pounds of fish and 60 pounds of

coconut per day. How many hours must Robinson and Friday work per day if they dont

help each other? Suppose they decide to work together in the most efficient manner

possible. How many hours each day do they have to work? What is the economic

explanation for the reduction in hours?

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6. Indicate whether each of the following statements is true, false or uncertain, and justify

your answer.

a. If everyone has the same marginal rate of substitution, then the allocation of

resources is Pareto efficient.

b. If the allocation of resources is Pareto efficient, then everyone has the same

marginal rate of substitution.

c. The Second Fundamental Theorem of Welfare Economics tells that the

competitive allocation of resources is socially desirable.