This document provides you with information on the upcoming tutorial, including:
(1) Exercises: you can be asked to work these out; you are expected to prepare them before class.
(2) Topic of the upcoming debate & pro/con-group, if applicable
Micro 2 Spring 2022 – Tutorial 1. Markets and efficiency
The following exercises are good practice for the upcoming midterm exam. In some cases, there are no right or wrong
answers; they are intended to invite discussion. The answers for the exercises not covered at the tutorial will be discussed
next week. We do not put answers on Canvas for exercises discussed during the tutorial.
Problem 1. Imagine two car traders, Harry and Jay. The only cars are Peugeots and Citroens. Quality is
not an issue; only taste matters. Suppose that Harry’s utility function is Uh=4P+2C and Jay’s utility
function is Uj=2P+4C, where P is number of Peugeots and C is number of Citroens on someone’s
premises. Suppose there are fixed amounts of 36 Peugeots and 16 Citroens.
(a) Suppose that the initial allocation is 12 Citroens to Harry and 8 Peugeots to Harry (leaving the rest
to Jay). Is this initial allocation efficient or not? Briefly explain.
(b) Consider the following statement: after all trading opportunities are exploited, Harry’s value of a
Peugeot (in terms of Citroens) is similar to Jay’s value of a Peugeot (in terms of Citroens). True or False,
briefly explain your answer.
(c) In the Edgeworth box below, show an indifference curve for Harry going through the initial allocation
(see above, under (b)) and an indifference curve of Jay going through the initial allocation. Explain why
it looks different from the indifference curves depicted in the lecture slides.
Please note: put Uh next to Harry’s curve and Uj next to Jay’s curve.
(d) With the initial allocation as starting point, show in which direction they may trade along their
indifference curves by adding an arrow to Harry’s curve and also to Jay’s curve, like this:
(e) In line with your answer on (d), draw the contract curve on the Edgeworth Box.
Problem 2. Your uncle says, while briefly taking his tobacco pipe out of his mouth:
“The market-based economy, i.e. capitalism, resulted in unprecedented growth
in living standards that no other economic system has ever achieved. This is the
reason why I believe that free markets are infinitely better than any of the
alternatives”.
Based on the first lecture, would you agree with your uncle or not. Briefly explain.
,Problem 3. Imagine two kids trading 20 football cards. The
only clubs are Feyenoord and Ajax. One kid has a preference
for Feyenoord, the other kid for Ajax, but they always want
to have at least one card of each club.
(a) Draw an Edgeworth box, with the number of Feyenoord
cards on the horizontal axis and the number of Ajax cards on
the vertical axis. The Feyenoord fan is in the bottom left
corner, the Ajax fan in the upper right corner.
(b) Draw one indifference curve for each kid.
(c) Consider the following statement: trading stops at the moment that both kids value the Feyenoord
cards in terms of the Ajax cards similarly. True or False? Briefly explain your answer.
(d) Mention two other factors that determine the exact point on the contract curve at which the two
kids end up after trading.
Problem 4. When air traffic goes back to pre-pandemic levels, London Heathrow airport is in need for a
third runway and a sixth passenger terminal. Last December, the U.K. Supreme Court lifted the ban on
the third runway, allowing a planning application to go ahead. Is the airport expansion likely to
constitute a Pareto improvement?
Problem 5. Provide an example of a policy that is a Pareto improvement (not one mentioned in the
textbook on page 64).
Problem 6. Using Hayek’s article, explain in terms that everybody can understand why markets can
achieve efficiency more easily than central planning. Again, make sure to use the term efficiency in the
way it was defined in the lecture/textbook.
Problem 7. Another uncle of yours is a
dairy farmer. He is proud of what has
been achieved in the industry, now
counting more than 1.5 mln cows:
“In the Netherlands, milk production
per cow more than doubled from 4,000
kg in 1960 to close to 10,000 kg in 2020
(see the figure to the right; note that
the best-performing cow of the
Netherlands produces 13,709 kg/year)
In the same period, labor input per kilo of milk was reduced by a factor of 15. In other words, cows
produce massive amounts of milk, with very little labor input. Milk production is incredibly efficient.”
Does your uncle’s concept of efficiency match with the concept of efficiency we use in welfare
economics? In what manner could this way of producing milk not be efficient from the perspective of
welfare economics?
Problem 8. Your airplane crashes in the Pacific Ocean. You land on a desert island with one other
passenger. A box containing 100 little bags of peanuts also washes up on the island. The peanuts are
the only thing to eat. In this economy with two people, one commodity, and no production, represent
the possible allocations in a diagram. Which allocation is Pareto efficient?
No in-class debate; no in-class experiment during this tutorial
, Tutorial 1
problem 4 4p 2c
= +
36 P Harry (=
12,p 8
=
162 Jay p 20
uj 2p 4c c 4,
= = =
=
+
a. 4.8 2.12 it is not efficient.
Un no
= +
=-
56 jay more c and Harry move p
ni 2.20 4.4 no, if
harry trades some peugeots for citroens
=
+
=72 Holding 4,1 72/ constant with jay then both will benefit
if allocate c=16
all to jay ->
72 2P
=
4
+ -
16
p 4 =
Harry will get
c 0,
=
P 36
=
-
4 32
=
=
UH 4.32 2.8
+
-120
b. MRs,""masc, but we have perfect
substitutes
*+
So we have false false, fixed marginal rate of
substitution. goods are substitutes
perfect
I
I
C
-7 12.....
↓
i ->
-
i
I
8
d
e.
⑧
8
Harry:
initial allocation:4 4p 2c 4.8 2.12 24 56
=
= + + =
32 + =
a possible second allocations:12 peugeots, then 156-12.4)/2 =4 citroens
Jay:
start with the initial allocation of 20 peugeots and 4 citroens to jay.
Vi 2P = +
4 2.24
=
4.4
+
56
=
16 x2
+
=
Then other points on jay's indifference curve should also have =72, e.g. where citroens:o . Then 2P=72, i.e. P 36 =
so that
makes the point
i n the left upper corner of the box. That
point
is shown in the box.
problem 2
Agree, but thatdoesn'tmean that intervention
government in markets cannot
improve things.
Think of environmentalpollution and inequality.
·but intervention
government does not necessarily lead to better outcomes socialist have an abysmal
regimes
record of environmental pollution
