Suppose that there are two goods, apples and oranges, and two individuals, John

Question

Suppose that there are two goods, apples and oranges, and two individuals, John and Mike.

John has four apples and two oranges, and Mike also has four apples and two oranges. We will call this “point A.”

A. Define what it means for an allocation of goods to be (Pareto) efficient.

B. What technical condition must hold for an allocation to be efficient?

C. Can you tell whether this allocation of apples and oranges (point A) is efficient? Why or why not?

D. Define the contract curve and explain the connection between the contract curve, efficient allocations, and the possibility of mutually beneficial trade.

E. Suppose that John and Mike are identical twins and have the same preferences (same utility function). Is this information of any use in deciding whether point A is efficient? Why or why not?

F. Mr. E. Konmajor says that if John and Mike have the same preferences, their contract curve is a straight line between the two corners (lower left and upper right) of the Edgeworth box. Is he right? Explain.

Explanation / Answer

a) Pareto efficiency, or Pareto optimality, is a state of allocation of resources in which it is impossible to make any one individual better off without making at least one individual worse off.

b) Pareto efficiency is obtained when a distribution strategy exists where one party's situation cannot be improved without making another party's situation worse.

c) no, because no information on utility is beinf provided.

d)  the contract curve is the set of points representing final allocations of two goods between two people that could occur as a result of mutually beneficial trading between those people given their initial allocations of the goods.

e) yes, it is.

f) yes, because of symmetry of utility functions.

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