Question
Econ 4100, Economics, Philosophy and Public Policy, Spring 2017
Problem Set 1, Wednesday, February 01, 2017
Due Wednesday, February 8, 2017
Purpose of this problem set: get yourself familiar with i) the economists’ interpretation of individual welfare and the assumptions embedded there, ii) the Pareto principle and Pareto efficiency, and iii) the normative aspects of market systems (we have not discussed these aspects yet); the main materials related to this problem set are covered in the weeks 3 and 4.
1. In Question 1 of PS 1, you worked the details of the two policies that intended to help individuals in need. In particular, you presented reasons suggesting that cash transfers are always “at least as good” for their recipients as in-kind transfers, and are sometimes better.
a. Explain how your reasoning and suggestion presented in Question 1 of PS 1 are based on the economist’s interpretation of a consumer’s welfare as preference satisfaction, and the underlying assumptions there.
b. However, government policies often involve in-kind transfers: this is the case for food, housing, education, legal services, health care, and many other goods, and in-kind transfers are often much more popular than cash transfers. Can you think of possible reasons that the government chooses in-kind rather than cash transfers in such cases? Make sure that you spell out your assumptions in the process of presenting your answers.
2. Recall the two policy options discussed in Summers’ memo:
Option A: the status quo
Option B: Moving the dirty industry from the developed country (DC) to the less developed country (LDC) and paying an appropriate compensation to the LDC by the DC
c. State the ranking of the two policy options by DC and by LDC according to the memo.
d. Is the Pareto principle applicable to the situation that you stated in c? If no, explain; if yes, which version of the principle (Pareto principle or/and weak Pareto principle) is applicable?
e. According to your stated ranking in c, between the two policy options, which one is Pareto efficient and which one is not Pareto efficient? Explain.
3. This question is based on one of your week 3’s reading: Daniel M. Hausman and Michael S. McPherson. 1997. Beware of Economists Bearing Advice. Policy Options 18 (7): 16-19.
f. In illustrating the economist’s argument for why welfare benefits should be provided in cash rather than in in-kind,Hausman and McPerson identify three main assumptions behind the argument. What are the three main assumptions behind the economist’s argument that they identify?
g. In their discussion in the SECTION, “Is the goal to increase well-being?”, what caution and complication should we be aware in articulating the goal(s) of the policy?
4. You and your sister are dividing a cake. Your sister is always craving for more food: she always prefers more to less. You, on the other hand, prefer more to less up to 1/3 of the cake; beyond that, you can still eat it but will not derive any extra utility. Consider the following divisions:
?:your sister has the whole cake and you have none.
?:you have the whole cake and your sister has none.
?:your sister and you share the cake equally.
?:you have 1/4 of the cake and your sister has 1/2 of the cake.
?:you have 1/3 of the cake and your sister has 2/3 of the cake.
h. Identify those divisions that are Pareto efficient. Explain your answers.
i. Identify those divisions that are weakly Pareto efficient. Explain your answers.
5. Consider four states, A, B, C and D. The utility numbers of the four states for the individuals are given below (there are three individuals in the society):
individual 1 individual 2 individual 3
A 5 2 1
B 0 5 6
C 3 3 5
D 4 5 6
j. Suppose all four states are feasible. Identify those states that are
j.1 Pareto efficient j.2 weakly Pareto efficient.
k. Suppose D becomes infeasible (so that there are three feasible states). Identify those states that are
k.1 Pareto efficient k.2 weakly Pareto efficient.
