Econ 441, Public Economics, Chapter 1:

Judging Whats Good for Society1

Dan Silverman
Arizona State University
Fall 2016

1 These

notes are adapted from Public Policyby Nicola Persico, Northwestern

University.

Contents
1 Judging Whats Good for Society
1.1 Preliminaries . . . . . . . . . . . . . . . . . . . . . . . . . .
1.1.1 References: Gruber, Chapters 2.1-2.2. Hyman, Appendix I. . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.2 Pareto E ciency . . . . . . . . . . . . . . . . . . . . . . . .
1.2.1 References: Gruber, Chapter 2.3 on Social E ciency.
Hyman p. 55. . . . . . . . . . . . . . . . . . . . . . .
1.3 Utilitarianism . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4 RawlsMaxiMin Concept . . . . . . . . . . . . . . . . . . . .
1.5 Practice Problems . . . . . . . . . . . . . . . . . . . . . . . .

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Chapter 1
Judging Whats Good for
Society
1.1
1.1.1

Preliminaries
References: Gruber, Chapters 2.1-2.2. Hyman,
Appendix I.

Denition 1 Agents: i = 1:::N

Denition 2 X the set of all possible (or feasible) allocations, x 2 X a
generic allocation.
Example 3 N = 2 agents, Art and Bob. We want a model of the division
of one dollar between Art and Bob. So X={The set of all possible ways of
allocating (positive amounts of) money to Art and Bob such that the sum
of what they receive does not exceed $1}. Then x is a particular allocation,
for example (0.50,0.50), (0.40,0.60), (0.20,0.70) and so on. In that last
allocation some money is wasted. It may not be a sensible thing to do, but
we want to account for the possibility of wasteful allocations. In this situation
we can denote the allocation as x = (xA ; xB ), where xA is the money that
Art receives and xB is the money that Bob receives. Then, the following
properties hold: xA
0; xB
0 (i.e., neither Art nor Bob have to give up
money), and xA + xB 1 (no more than $1 is distributed).
Remark 4 The split-the-dollar example may seem so simplistic as to be silly,
but it is an important benchmark. It describes a situation in which a given
1

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

amount of resources must be allocated among several agents (in this case 2).
In broad terms, this is the same problem legislators or university administrators face when determining how allocate a budget surplus (or deciding who
bears the cost of nancing a decit).

Example 5 N = 1 agent, two goods, leisure and bread.

Bread

Bread

0 hrs

24 hrs

Leisure

0 hrs

In the case of leisure and bread, the set X is used to represent a production
function, i.e., a technology that can transform leisure (or its complement,
labor) into bread at a certain rate.

Discussion Why does it makes sense to have free disposal and what is its
graphical interpretation.

Denition 6 A set X is convex if, for each two elements x and x0 of X, the
element y = x + (1
) x0 also belongs to the set X.

Discussion The meaning of convexity of the set X.

Example 7 N = 2 agents, two goods. Edgeworth Box

24 hrs

Leisure

1.1 PRELIMINARIES

Donuts for Bob

Donuts for Art

Coffee for Bob

Coffee for Art

Denition 8 Utility function, for each i = 1:::N the utility that agent i
derives from an allocation x is denoted by ui (x).

A relatively large value of ui denotes agent is relatively high level of

satisfaction with allocation x. That is, given a choice between x and x0 ,
agent i would take x:

Example 9 When splitting a dollar, assume Art only cares about the money
he receives and not about the money Bob receives. Then, we have uA (x) =
uA (xA ). If, in addition, we assume Art prefers more money to less, then
uA (xA ) is an increasing function of xA . One special form of utility function
is a linear one, where uA (xA ) = xA . If Art were spiteful, i.e., if he resented
the fact that Bob receives money independently of how much Art himself
receives, then we would have uA (x) = uA (xA ; xB ) with uA being a decreasing
function of xB .

Example 10 In the leisure and bread example, each leisure-bread combination gives a certain level of utility u (l; b). We can connect all the points that
give the same level of utility through an indierence curve.

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

Bread

Bread

Indifference curve
Convex indifference curve

0 hrs

24 hrs

0 hrs

24 hrs

Discussion Monotonicity of preferences and its graphical interpretation.

Convex indierence curves.

Example 11 Indierence Curves in the Edgeworth Box

Coffee for Bob

Donuts for Art

Donuts for Bob

Bob
s indifference curve

Art
s indifference curve

Coffee for Art

1.2 PARETO EFFICIENCY

1.2
1.2.1

Pareto E ciency
References: Gruber, Chapter 2.3 on Social E ciency. Hyman p. 55.

There is no such thing as a free lunch ...Around

the turn of the

century Vilfredo Pareto, a vigorous advocate of analytical economics, met Gustav
von Schmoller, the leader of the socially oriented Historical School of Economics.
Pareto was well aware that Schmoller was critical of his idea that one could establish physics-like laws in economics, and once when Pareto was lecturing in Geneva
Schmoller noisily interrupted him by shouting, There are no laws in economics!
Pareto got annoyed and decided to teach Schmoller a lesson. He got his chance
the next day when he saw Schmoller in the streets of Geneva. Pareto approached
Schmoller and hid his face, pretending to be a beggar (which was not too di cult
since Pareto was a shabby dresser). Please, Sir, Pareto said, can you tell me
where I can nd a restaurant where you can eat for nothing? Schmoller replied,
My dear man, there are no such restaurants, but there is a place around the corner
where you can have a good meal very cheaply. Ah, said Pareto triumphantly,
so there are laws in economics! [Vilfredo Pareto, The Mind and Society, New
York: Dover Publications, 1935:xviii]

Denition 12 An allocation x is Pareto e cient (or Pareto optimal) if

there is no other allocation x0 such that for all i, ui (x0 )
ui (x) and the

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

inequality is strict for at least one i.

In words: an allocation is Pareto e cient if there is no other feasible

allocation that would make at least one person in society strictly better o
while making no one else worse o. As we will see in the examples below,
Pareto optimality often is not a very demanding or controversial notion of
what is good for society; an allocation must be wasteful in order not to
meet the requirement of Pareto optimality.

Remark 13 In the case N = 1 the notion of Pareto e ciency reduces to

utility maximization.

Example 14 In the split-the-dollar example, all allocations x = (xA ; xB )

such that xA 0; xB 0 and xA + xB = 1 are Pareto e cient, since there is
no way to make both agents simultaneously better o. Notice, however, that
we have ruled out allocations such that xA + xB < 1, since those allocations
can be Pareto improved upon.

Remark 15 In general, there are many Pareto optimal allocations within a

set X.

Remark 16 In this example, the allocation xA = 0; xB = 1 is among the

Pareto optimal ones. Similarly, the allocation xA = 0; xB = 1 is also Pareto
optimal. An important lesson is that the notion of Pareto optimality is blind
to equity concerns.

Example 17 In the Edgeworth box, the point x is not Pareto optimal, as

any point x0 lying in the shaded lens gives higher utility to both agents.

1.2 PARETO EFFICIENCY

Coffee for Bob

Donuts for Art

Donuts for Bob

Bob
s indifference curve

Art
s indifference curve

Coffee for Art

Since the same argument can be replicated for any point at which the
indierence curves cross (and hence form a lens), the set of Pareto optimal
points in the Edgeworth box is the set of points at which indierence curves
are tangent (and so a lens does not form). The set of Pareto optimal points
in the Edgeworth box is traditionally called the contract curve.

Donuts for Art

Donuts for Bob

Coffee for Bob

Coffee for Art

Take any point x on the contract curve: there is no other point that makes
both agents better o than x. Of course, there are points at which one player
is better o, but then the other agent is worse o. That is, the contract curve

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

identies Pareto optimal points.

Example 18 Points on the contract curve express pure conict of interest,
in the sense that no mutual improvements are possible: any movement along
the contract curve favors one agent and hurts the other.
Example 19 Consider the following way of representing X. Each element
x is a square in the array below, so for example x = (a1 ; b3 ) is an allocation.
The rst number reported in the (a1 ; b3 ) position represents u1 (x), the utility
of agent 1 at x (in this case, 10); the second number represents the utility of
agent 2. Find the Pareto optimal allocations.
1n2 b1

b2
50; 0 0; 5

a1
a2

10; 0

10; 0

a3

15; 10 30; 10

b3
10; 0
10; 0
5; 25

Example 20 Pareto e ciency with production. Consider one agent (N = 1)

who has preferences over leisure and bread. Initially, that agent is endowed
with 24 hours of leisure and no bread, but there exists a production technology
that transforms labor (the absence of leisure) into bread. Here, the set X of
allocations is the set of production possibilities, the set of pairs of bread and
leisure that the agent can enjoy given that he is endowed with 24 hours of
leisure and no bread.
Bread

Optimal production mix

Production possibilities

0 hrs

24 hrs

Leisure

1.2 PARETO EFFICIENCY

Remark 21 The set of Pareto-optimal allocations is invariant to monotone

transformations of the agentsutility functions.
Discussion: ordinality of utility function: di culty of obtaining cardinal
representation.

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CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

1.3

Utilitarianism
The Auto-Icon

At the end of the South

Cloisters of the main building of UCL stands
a wooden cabinet, which has been a source of
curiosity and perplexity to visitors. The cabinet contains Benthams preserved skeleton,
dressed in his own clothes, and surmounted
by a wax head. Bentham requested that his
body be preserved in this way in his will made
shortly before his death on 6 June 1832. The
cabinet was moved to UCL in 1850. Not surprisingly, this peculiar relic has given rise to
numerous legends and anecdotes. One of the
most commonly recounted is that the AutoIcon regularly attends meetings of the College Council, and that it is solemnly wheeled
into the Council Room to take its place among
the present-day members. Its presence, it is
claimed, is always recorded in the minutes
with the words Jeremy Bentham - present but
not voting.

Jeremy Bentham (1748-1832) is the founder of Utilitarianism. In A Fragment on Government, 1776, Bentham states his fundamental axiom:
It is the greatest happiness of the greatest number that is the measure of
right and wrong.
We formalize Benthams axiom as follows:
max [U1 (x) + U2 (x) +
x2X

+ UN (x)]

Example 22 Consider again spliting the dollar between Art and Bob. Since
xB = 1 xA , Benthams axiom reduces to
max [UA (xA ) + UB (1

xA 2[0;1]

xA )] :

11

1.3 UTILITARIANISM

Taking a derivative with respect to xA and equating to zero (remember: a

necessary condition for maximizing a function), we get
UA0 (xA )

UB0 (1

xA ) = 0:

(1.1)

Utilitarianism, that is, prescribes equalizing the derivative of the agentsutility functions. The derivative of an agents utility function is called marginal
utility.
p
p
Example 23 Suppose UA (xA ) = xA and UB (xB ) = xB : Then
1
1
UA0 (xA ) = p ; UB0 (xB ) = p :
2 xA
2 xB
Substituting into equation (1.1) yields
1
p
2 xA

p
2 1

1
xA

= 0:

This is an equation in xA that can be solved to yield xA = 1=2 (and, consequently, xB = 1=2).
Under suitable assumptions on the shape of the utility function, equation
(1.1) has a unique solution (as happens in the above example). This means
that, in the split-the-dollar problem, the utilitarian criterion selects a unique
solution. Uniqueness is a nice feature. Compare this feature of the utilitarian
criterion with the concept of Pareto optimality, which in the split-the-dollar
problem fails to give meaningful guidance (all splits that do not waste are
Pareto optimal).
But the situation is not as clear-cut as it looks. The utilitarian notion
only side-steps the problem of multiplicity, it does not solve it. The problem
is that is very di cult (impossible?) to measure the slope of the utility
function of each individual. For example, it is hard to know whether Bobs
p
p
utility function is really xB or, perhaps, 3 xB . If Bobs utility function
p
were in fact 3 xB then Bob would value money more than Art. But in this
case the utilitarian principle requires that Bob get more than 1/2 dollar,
since money supposedly produces more social utility when it is given to Bob.
To see how the utilitarian allocation changes when we multiply Bobs
utility function times 3, write down equation (1.1) taking into account Bobs
new utility. We get
1
p
2 xA

p
2 1

1
xA

= 0:

12

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

1
9
Solving for xA now yields xA = 10
, which means that Bob is getting 10
. This
is consistent with the notion of utilitarianism, but suggests that Art and Bob
both have an incentive to misrepresent their utility for money, and claim to
have a larger marginal value of money.

Remark 24 The welfare-maximizing allocation is invariant to transformation of the utility functions that amount to summing a (possibly agent-specic)
constant, but they are not invariant to multiplication by a constant.

1.4

RawlsMaxiMin Concept

John Rawls (1921-2002) suggests that allocations should be ranked according to the satisfaction of the person that is worse o in that allocation. This criterion is sometimes called maximin since it is equivalent to
maximizing the satisfaction of the agent with the minimum level of satisfaction.
The Rawlsian criterion has serious bite. Consider, for example, an allocation x that gives all agents a utility of 10 and another allocation x0 that
gives agent 1 a utility of 9 and all other agents (possibly very many) a utility
of 100. In this case, according to Rawlsview, allocation x is preferable to
x0 .
Example 25 In the split-the-dollar game between Art and Bob the maximin
allocation is the (0.50,0.50) split. In all other allocations, the worst-o agent
fares worse than the worst-o agent(s) in the (0.50,0.50) allocation.

1.4 RAWLSMAXIMIN CONCEPT

13

As the previous example shows, in a redistributive world Rawlsmaximin

criterion requires equalizing utility level across agents. The same caveats
concerning the measurement and misrepresentation of preferences apply as
in the discussion of the Utilitarian principle.
The Rawlsian maximin principle addresses a concern for inequality by
focussing on the plight of the worst o in society. It does so in a rather
extreme, but logically consistent, way. The maximin principle appears to be
founded in a concern for the less fortunate. However, the maximin principle
was rationalized by Rawls as a decision taken by selsh individuals before
each individual knew what his or her situation would be (Rawls used the
terms original positionand behind the veil of ignorance). Rawls reasoned
that, behind the veil of ignorance, selsh individuals would care about the
plight of the worse-o because of the fear that they might be in that place.
Example 26 Suppose there are two agents, Mr. 1 and Ms. 2, and a car.
Mr. 1 values the car at $X1 and Ms. 2 at $X2 ; where X1 > X2 : The car
is initially owned by Ms. 2. Mr. 1 can get the car, however, if he transfers
money to Ms. 2 in return for the car. Apart from the car, there is money
$M to be allocated between the two agents. The utility of each agent is given
by
u1 (car; m) = X1 + m;
u2 (car; m) = X2 + m;

u1 (no car; m) = m;
u2 (no car; m) = m;

where m is money. We assume M > x1 :

What is the utilitarian allocation?
First note that it doesnt matter for the utilitarian allocation how the
money is split since the sum of money will be M anyway. Then, who
should get the car? Since Mr. 1 derives a higher utility from the car, the
car should be given to him to maximize the sum of individual utilities.
In this case, the maximized utility will be X1 + M: Note that at the
initial allocation in which Ms. 2 owns the car, the sum of utilities is
only X2 + M:
What is the Pareto e cient allocation?
We can easily see that any allocation of money is Pareto e cient as
long as the car is given to Mr. 1.

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CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

Suppose now that cars can be produced at a marginal cost c: What is
the utilitarian allocation in this case?
The sum of utilities if two cars are produced is X1 + X2 + M 2c; or
equivalently, (X1 c) + (X2 c) + M: If only one car is produced and
owned by Mr. 1, the sum is (X1 c) + M: If no car is produced, then
the sum is just M: Now, the answer depends on which of these social
utilities is the largest. It is straightforward to see that (i) if c < X2 ;
producing two cars is optimal, (ii) if X2 < c < X1 ; producing one car
for Mr. 1 is optimal, and (iii) if c > X1 ; not producing at all is optimal.
The same logic holds in the case of Pareto optimality.

Remark 27 The maximin allocation is not invariant to transformation of

the utility functions, not even those that amount to summing agent-specic
constants.

1.5 PRACTICE PROBLEMS

1.5

15

Practice Problems
Exercise 1.1

With a given technology, 3 loaves of bread can be produced with 4 hours

of work. What is the implication of the fact that free disposal holds for this
technology?
A. Less than 3 loaves can be produced using 4 hours of work.
B. 3 bushels can be produced using less than 4 hours of work.
C. More than 3 loaves can be produced using 4 hours of work.
D. 0 loaves can also be produced using 0 hours of work.
Exercise 1.2
An agent values leisure and bread and has convex indierence curves.
The agent strictly prefers a = (10 hrs, 4 loaves.) to b =(2 hrs, 10 loaves).
There is another allocation c =(6 hrs, 7 loaves.). Someone says, Allocation
c is a mixture of a and b: And a is strictly better than b: Therefore, the agent
necessarily prefers a to c.
a) Show how c is related to a and b:
b) Is the above statement true or false?
Exercise 1.3
Two football teams A and B are competing for a championship. Team A
has 1; 000 fans and Team B has 100: A team A fans payos when A wins,
ties, and loses are 100; 70; and 50 in that order. A team B fans payos when
B wins, ties, and loses are 200; 30; and 10 in that order.
a) Find all the Pareto optimal outcomes.
b) Which team should win according to the utilitarian criterion?
c) Which team should win according to the Rawlsian criterion?
Exercise 1.4
Consider a variation of the spit-the-dollar game. The only dierence is
that now when two agents agree on (0:5; 0; 5) ; each gets 0:1 as a bonus.
What are the Pareto optimal allocations? (An allocation species how much
each agent ultimately gets.)
Exercise 1.5

16

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

Without going to college individuals cannot work and thus cannot earn
money. Going to college costs $100,000 and allows an individual to earn
$200,000. There are two individuals in society. The utility function is the
same for both individuals and is linear in money, u (m) = m. The sum of the
two individualsendowment (before they decide whether to go to college) is
$200,000. An allocation in this economy species who goes to college and
how much money each individual gets (from earnings plus whatever part of
the endowment remains after college tuitions are paid).
a) What is the utilitarian allocation?
b) Describe the set of Pareto-optimal allocations assuming that the increased earnings from going to college can be transferred among agents.
c) Describe the set of Pareto-optimal allocations assuming that the increased earnings from going to college cannot be transferred among agents.
d) Suppose now agent 1 is endowed with all the money in the economy
($200,000), and agent 2 has no endowment. Given the price of education,
who will go to college? (Assume that individuals cannot borrow.)
Exercise 1.6
There are two agents, A and B. Consider the set X of feasible allocations
which contains four allocations x1 ; :::; x4 . The utilities that the two agents
receive in each allocation are given below.
x1

x2

x3

x4

uA

uB

a) List all Pareto-optimal allocations.

b) What is the best allocation according to Rawlsmaximincriterion?
Suppose agents A utility from outcome x is not given by uA (x) but by
u
eA (x) = uA (x) + c, where c is a positive constant.
c) How large must c be in order for x3 to be the best allocation according
to Rawlsmaximincriterion?
d) How large must c be in order for x2 to be the best allocation according
to Rawlsmaximincriterion?
Exercise 1.7

1.5 PRACTICE PROBLEMS

17

Jane has a utility of $5 for being on the swing. Dick has a utility of $3
for being on the swing.
First, let us consider the set of allocations where the swing goes to one
of the two kids. The swing is the only good in this economy.
a) Does the allocation where Jane gets the swing Pareto-dominate the
allocation where Dick gets the swing?
b) What is the set of Pareto-optimal allocations?
Now, assume that each kid has $10 in his pocket. In this economy there
are two goods, swing and money. Thus, an allocation prescribes who gets
the swing as well as a division of the total amount of money in society ($20).
Let us consider the set of allocations of swing and money.
c) Show that the allocation where Dick gets the swing and each kid keeps
$10 is Pareto-dominated.
Exercise 1.8
An agent values leisure and wheat. The agent is indierent between the
allocation (24 hrs., 0 lbs.) and the allocation (0 hrs., 100 lbs.). The agent
has convex indierence curves.
a) What do we know about the agents utility for the allocation (18 hrs.,
25 lbs.)? Hint: 18 is 3/4 of 24.
b) What do we know about the agents utility for the allocation (12 hrs.,
60 lbs.)?
Exercise 1.9
a) Draw the average persons indierence curves for the utility over left
and right shoes. (For this question assume that all shoes are of the same
style).
b) Now consider a veteran who is missing his right leg. Draw his indifference curves for the utility over left and right shoes.
c) Now draw the indierence curves for my dogs utility function for shoes.
My dog chews shoes, so left and right are excellent substitutes.
Exercise 1.10

18

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

There are two agents, A and B. Consider the set X of feasible allocations
which contains four allocations x; z; y; w. The utility that the two agents
receive in each allocation are given below. following allocations for
x

uA

0 1

uB

8 1

a) List all Pareto-optimal allocations.

b) What is the best allocation according to the utilitarian criterion?
c) What is the best allocation according to the Rawlsmaximin criterion?
Exercise 1.11
The Arizona Department of Transportation must nance the maintenance
for a bridge, and is considering raising the money by charging motorists for
crossing the bridge in the morning. There are two types of motorists, gogetters (who cross the bridge at 8:00 AM), and slackers (who cross it at 11:00
AM). Daily disposable income is $400 for each go-getter, $11 for each slacker.
Slackers and go-getters have the same utility function for money m, equal to
p
m. Thus, if a go-getter
is made to pay $ t to cross the bridge then his/her
p
daily utility equals 400 t.
Knowing that there is an equal number of go-getters and slackers, and
knowing that the ADOT evaluates allocations as a utilitarian, which policy
would the authority choose: to charge all motorists $2 for crossing, or to
charge go-getters $4 and let slackers cross for free?
Exercise 1.12
With a given technology, 3 loaves of wheat can be produced with 4 hours
of work, and 5 loaves can be produced with 6 hours of work. If you know
that the production possibility set representing this technology is convex,
what can you deduce? (Pick one answer below).
A. Less than 3 loaves can be produced using 4 hours of work.
B. 6 loaves can be produced with 8 hours of work.
C. 4 loaves can be produced with 5 hours of work.

1.5 PRACTICE PROBLEMS

19

D. 0 loaves can also be produced using 0 hours of work.

Exercise 1.13
Consider a persons preference for left and right shoes. Let (xL ; xR ) denote
an allocation representing the quantity of left and right shoes, respectively.
The persons preference for shoes is given by
u (xL ; xR ) = min fxL ; xR g :
The person is endowed with 2 left and 4 right shoes. You may think of
shoes as a discrete or a continuous variable, depending on what is easier for
you.
a) What is utility level that the person receives from her endowment?
b) Depict the persons indierence curves in the cartesian plane with axes
xL (vertical) and xR (horizontal).
c) Are the persons indierence curves convex? Explain why or why not.

Exercise 1.14
Consider a split-the-dollar world in which one dollar is to be divided
among two agents, A and B. That is, let (xA ; xB ) represent the share of
the dollar allocated to agents A and B, respectively. Let the agentsutility
functions over the feasible allocations be dened as follows:
uA (xA ) = xA
uB (xB ) = 2xB ;
where xi represents the share of the dollar allocated to player i.
a) What is the set of Pareto optimal allocations?
b) What is the utilitarian allocation?
c) What is the Rawlsian allocation?
d) Suppose henceforth that agent A is spiteful, and that his utility function is given by
uA (xA ; xB ) = xA 2xB :

20

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

Answer questions a) through c) under this new assumption.

Exercise 1.15
An individual has preferences over two goods, apples and oranges. Let
x = (2; 6) denote the allocation in which the individual receives 2 apples and
6 oranges. Analogously, let y = (6; 2) and z = (5; 5).
a) Suppose you know that the individuals preference are monotone (though
not necessarily convex) and that the individual is indierent between x and
y. Could the individual prefer x and y to z? Justify your answer.
b) Suppose you know that the individuals preference are monotone, convex, and that the individual is indierent between x and y. What can you
conclude about the individuals relative evaluation of x; y; and z ? (For example, can you say that z is preferred to x and y, or vice versa?) Justify
your answer.
c) Suppose you know that the individuals preferences are monotone,
and that the individual is indierent between x, y; and z. What can you
conclude about the convexity of the individuals indierence curves? Justify
your answer.
Exercise 1.16
There are two agents, A and B. Consider the set X of feasible allocations
of widgets which contains four allocations x1 ; :::; x4 where xj = (xAj ; xBj ).
The utility that agent i receives from his allocation is given by the function
p
xij . The following table describes the set of feasible allocations X:
x1

x2

x3

10 7

12

x4

a) List all Pareto-optimal allocations.

b) List all the best allocations according to the Utilitarian criterion
c) List all the best allocations according to the maximin criterion
d) How would your answers to parts (a)-(c) above change if instead
p
uB (x) = xBj + 10: Discuss briey.

1.5 PRACTICE PROBLEMS

21

e) How would your answers to parts (a)-(c) above change if instead

p
uB (x) = 10
xBj : Discuss briey.

Exercise 1.17
After eating at a restaurant, Ann and Barbara must agree on how to
split a bill which totals $60. Anns utility function for money is given by
uA (m) = 2m. Barbaras utility function is given by uB (m) = 4m: Each
friends wealth before paying the bill equals $100.
a) What is the set of Pareto optimal splits of the bill? Discuss briey.
b) What is the utilitarian split of the bill? Calculate the social utility
associated with such an allocation. Discuss briey.
c) What is the set of maximin splits of the bill? Discuss briey.
a) Set of Pareto optimal split is {(xA , xB ) : xA + xA = 60} .
b) max UA (xA ) + UB (60 xA ) = 2(100 xA ) + 4[100 (60 xA )] .Notice
that UA + UB is increasing in xA . Utilitarian split is (60, 0) and UA + UB =
2(100 60) + 4 100 = 480:
.
c) maximin split: UA = UB ) 2(100 xA ) = 4[100 (60 xA )] ) xA = 20
3
Exercise 1.18
Consider a production function in which one bushel of wheat is produced
for each hour of labor put in, but only after the agent has put in the rst 2
hours of labor. You may think of the rst two hours as a xed cost time
spent commuting to and from the workplace, for example. Assume that there
is free disposal, so that it is technologically feasible to throw away wheat.
a) Draw the production possibility set on the cartesian plane with axes
Labor and Wheat. Put Labor on the horizontal axis.
b) Is the production possibility set convex? Explain.
Exercise 1.19
A society has three agents, A, B and C: Consider the set of feasible
allocations which contains four possibilities: x; z; y; w. The utility that each

22

CHAPTER 1 JUDGING WHATS GOOD FOR SOCIETY

agent receives from each allocation is given below.

x

uA

10 0

uB

16 2

uC

a) What allocations are best according to the Pareto criterion?

b) What allocations are best according to the utilitarian criterion?
c) What allocations are best according to the maximincriterion?
d) Choose one criterion (Pareto e ciency, Utilitarianism, or maximin)
and make a brief argument explaining the advantages of this criterion over
the other two.
Exercise 1.20
Consider a production process that translates a workers leisure into bread
so that
b (l) = 100 l2
where l 2 [0; 10] denotes leisure and b (l) is the amount of bread produced as
a function of leisure.
(a) Assuming free disposal, draw the production possibility set on the
Cartesian plane with axes leisure and bread. Put leisure on the horizontal
axis.
(b) Is the production possibility set convex? Explain your answer using
either a formal denition of a convex set or an illustration on your drawing.
(c) Explain what your answer to part (b) (convex or not) implies about
the returns to scale of this production process.
Now suppose that the worker may consume the bread produced with her
labor (the complement of leisure). Her preferences over leisure and bread are
monotonic, and she is indierent between three allocations x = (10; 0); x~ =
(0; 100) and x^ = (6; 64) :
(d) On the Cartesian plane with axes leisure and bread (leisure on the
horizontal axis), draw an indierence curve through the points x; x~ and x^.
Indicate on your drawing the allocations that are in the better-than set

1.5 PRACTICE PROBLEMS

23

dened by the indierence curve you drew. The allocations in the better-than
set do not have to be feasible.
(e) Now consider the set, call it Y; consisting of allocations in the betterthan set you drew. Is that set Y convex? Explain your answer using either
a formal denition of a convex set or an illustration on your drawing.
(f) Explain what your answer to part (e) (convex or not) implies about
whether the marginal utility the worker receives from additional consumption
of leisure is increasing or decreasing in the level of leisure.