Answer no. 05
Suppose in the initial allocation the following situation prevailed: MRSAom = 4 and MRSKom = 3.
Keya can offer one orange to Apu for 3 mangoes and 3 mangoes can give her the same satisfaction as before and the exchange make her better off than before, because she has 1 more mango left. This means the initial situation was not Pareto efficient.

Answer no. 06
Suppose in the initial resource allocation, MRSAom = 4 and MRTom = 3.
Apu can reduce mango production by 3 units and gain 1 unit of orange. He can exchange 1 orange for 3 units of mangoes and can improve his situation because he gains 1 unit of orange in the process. This again implies that the initial allocation was not Pareto efficient.

Answer no. 07
We need government intervention even if the First Fundamental Theorem of welfare economics is satisfied because the initial allocation of resources can lead to a point on the grand utility possibility curve, which sustains a very unequal distribution of income and puts the economy on a lower social indifference curve. The government can change the initial allocation of resources such that the distribution of income can be made socially desirable without affecting the Pareto efficiency condition.

Answer no. 08
The situation in which price becomes greater than marginal cost, as in a monopoly market, cannot be Pareto efficient because marginal valuation of the consumer for the commodity as expressed by MRS exceeds MRT and in this situation the society’s total welfare can be increased by increasing the production of the commodity.

Answer no. 09
Markets fail for commodities with externalities because the market production of the commodity exceeds the socially optimal level in case of negative externality and production less than the socially optimal level in case of positive externality.

Book exercises:

Answer no. 01 a. Beach houses are all high risk properties as it have a high level of uncertainty. Since, near the beach flood occurs very frequently and the insurance firm must have to pay for the damages frequently, it gets no profit at all. So the market for flood insurance does not exist for such houses and efficient outcomes cannot be expected in this case. b. Medical care is provided by both public and private sector and they can be price makers. A market where not both parties are price takers cannot be expected to be efficient. c. Buyers and sellers of stock are not price takers. They can both heavily influence the price and as the market information are asymmetric, people who have more information makes more profit. Therefore the stock market cannot be expected to be efficient. d. In the market for personal computer, price can be influenced easily by the manufacturers. This means, the firms know whatever the price they are going to charge their customer will buy it and therefore efficient outcomes cannot be expected. e. Market for student loans is likely to be inefficient because the price of the loan or the interest rate at the beginning can be changed by the lending body later on. f. Market for car insurance is unlikely to be efficient because the interest payment of the insurance contract may be set by the insurance company and it can even deny service of paying the damage costs to certain people.

Answer no. 02

In the Edge- worth box, XY is the line that allocates exactly half of the available water to each person.

Henry and Catherine are not allowed to trade between themselves to get more water or bread, even though they have been given equal share of water. As we know, it is highly unlikely that each unit of bread or water gives both the individuals the same level of utility. Because, one may value water more than bread or value bread more than water. So their MRS may not be equal, and thus such an allocation is unlikely to be Pareto efficient.

Answer no. 03

The government of France imposing tax on foreign movies makes them more expensive compared to local movies. As a result both the marginal rate of substitution and marginal rate of transformation values change. People will have to give up a greater number of local movies to watch one foreign movie. Similarly, movie theatres will have to give up more local films to show one foreign film. Thus the policy is not consistent with Pareto Efficiency, because same movie produced outside the country by using same amount of resources is more costly than the movie produced domestically.

Answer no. 04

a)

The Social Welfare function is W = UL + UA

UL is the utility of Livia

UA is the utility of Augustus

At every point in the social welfare curve, the different combinations of utilities show same welfare of the society. However, if we consider point ‘X’, Livia gets maximum utility by OL and Augustus gets minimum utility by OA. The opposite scenario happens at point ‘Y’. Even though the society welfare is same at these points, these are also called unfair distribution of income.

b)

Now, the Social Welfare function is W = UL + 2UA

The social welfare curve will be at a higher stage. Even though the social welfare is maximized and same for both of them, the utility of Augustus is valued twice as much as the utility of Livia.

c)

If the society values Augustus’ utility more than Livia’s, then a large amount of the resource will be allocated for Augustus.

Answer no. 09

Here MRSCT = 2, and MRTCT = 1/3. Since MRS is not equal to MRT, this is not a Pareto efficient condition. There should be more crumpets for the resources to be Pareto efficient.

Answer no. 10

a. FALSE – it is only one of the conditions to be satisfied for an allocation to be Pareto efficient. The marginal rate of substitution of each individual should be equal to the marginal rate of transformation. b. TRUE – It is one of the conditions which need to be satisfied for an allocation to be Pareto efficient. c. TRUE – The vaccinated individual also eliminates risk of other people around him from being infected by him. d. FALSE – The second fundamental theorem tells us that the society can attain any Pareto efficient allocation of resources by making a suitable assignment of initial endowments