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Questions and Problems - Fundamentals of Welfare Economics

The document outlines questions and problems related to Public Economics and Finance, focusing on welfare economics, production functions, and utility functions in trade economies. It includes tasks such as drawing Edgeworth boxes, determining Pareto-efficient allocations, and discussing fundamental theorems of welfare economics. Additionally, it prompts comparisons of resource allocations based on the Pareto criterion and explores the relationship between equity and efficiency.

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brls22
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29 views

Questions and Problems - Fundamentals of Welfare Economics

The document outlines questions and problems related to Public Economics and Finance, focusing on welfare economics, production functions, and utility functions in trade economies. It includes tasks such as drawing Edgeworth boxes, determining Pareto-efficient allocations, and discussing fundamental theorems of welfare economics. Additionally, it prompts comparisons of resource allocations based on the Pareto criterion and explores the relationship between equity and efficiency.

Uploaded by

brls22
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Public Economics and Finance

Questions and Problems


(2024/2025)

1. Fundamentals of Welfare Economics

1. Consider an economy with two firms, Firm 1 and Firm 2, using two inputs—labor (L) and
capital (K)—to produce their respective goods, Y1 and Y2. The economy's total amount of
labor and capital is fixed and given by 𝐾̅ and 𝐿̅. Finally, assume that a Cobb-Douglas
function can represent the production function of each firm.

a. Draw an Edgeworth box for this economy, identifying the axes corresponding to
each firm.
b. In the Edgeworth box, illustrate an initial endowment of capital and labor for both
firms. Consider an initial allocation where the isoquants of both firms cross at that
point.
c. Based on the initial allocation in b), determine the area representing all possible
Pareto improvement allocations.
d. Define “contract curve”. What condition must be satisfied for all input allocations
along that curve?
e. Explain what a Production Possibilities Frontier (PPF) is and discuss its relationship
to the contract curve. Finally, plot a PPF that clearly identifies the initial
endowment allocation and the area corresponding to all potential Pareto
improvements.

2. Consider a trade economy with two goods, X and Y, and two consumers, A and B. Each
consumer has the following Cobb-Douglas utility functions: 𝑈𝐴 = 𝑋𝐴0.6 𝑌𝐴0.4 and Consumer
B: 𝑈𝐵 = 𝑋𝐵0.3 𝑌𝐵0.7

The total endowments of the goods are 𝑋̅ = 100 and 𝑌̅ = 100. Also, consider the
̅̅̅
following initial endowment distribution, 𝑋 ̅̅̅̅ ̅ ̅̅̅
𝐴 = 40, 𝑋𝐵 = 60, 𝑌𝐴 = 60 and 𝑌𝐵 = 40

a. Plot the Edgeworth box, indicating the initial endowment and the corresponding
indifference curves for both consumers
b. Derive the contract curve by finding the Pareto-efficient allocations for X and Y
and plot it in the Edgeworth box.
c. Plot the utility possibilities frontier (UPF), identifying all Pareto improvement
allocations starting from the initial endowment position.

3. Consider a trade economy with two goods, X and Y, and two consumers, A and B. Each
consumer has the following Cobb-Douglas utility functions: 𝑈𝐴 = 𝑋𝐴0.5 𝑌𝐴0.5 and Consumer B:
̅̅̅
𝑈𝐵 = 𝑋𝐵0.5 𝑌𝐵0.5 . The initial endowment distributions are as follows: 𝑋 ̅̅̅̅ ̅
𝐴 = 9, 𝑋𝐵 = 41, 𝑌𝐴 = 49
and ̅̅̅
𝑌𝐵 = 1

a. Plot the Edgeworth box, indicating the initial endowment and the corresponding
indifference curves for both consumers
b. Consider an allocation in which both individuals consume equal amounts of both
goods. Is this a Pareto Efficient allocation?

4. How does the Second Fundamental Theorem differ from the First Fundamental Theorem
of Welfare Economics?

5. How does the Second Fundamental Theorem address the relationship between equity and
efficiency?

6. List three key assumptions necessary for the Second Fundamental Theorem of Welfare
Economics to be valid.

7. The following figure represents a Utility Possibilities Frontier (U.P.F.).

a. Compare the resource allocations represented by points 1 and 2 based on the


Pareto criterion.
b. Using only the Pareto criterion, is it possible to determine which of the following
resource allocations is associated with a higher level of social welfare?
i. Points 2 and 4;
ii. Points 1 and 4;

c. Comment on the following statement: "A Pareto movement is always desirable


from a social perspective."

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