Economics Homework-8

(1)

If you were to examine where the USA might be on its Utility
Possibilities Curve, which, say, shows a trade-off in Utility between
the Rich and the Poor sections of society (in terms of what each sector
consumes), where do you think we would lie on the curve? Given your
opinion, who do you think placed us where we are on the curve? The
government? Certain people? Luck? Are you content with where you have placed us?

Assuming that our markets are reasonably efficient, could you draw an
Edgeworth Box that shows where you think the two classes of consumers
lie?

(2)

In lecture I mentioned Merit Goods. Can classical concerts, public art
and other publicly provided services be justified using the idea that
merit goods are simply good for the community?

(3)

Name and defend four reasons why might government intervention be needed in a market?

(4)

Here is sort of a repeat question from an earlier homework/discussion
for emphasis. Using the usual supply and demand curves (lines) please
show how a tax on the consumption of a product X MUST decrease welfare
in the market even if all of the tax is given back to the people in the
form of a cash payout. Show as well that if the government is simply
interested in raising money, it is better off taxing products whose
demand curves are relatively steep.

(5)

Now here is a problem to work through. If you really understand it, you
will have a firm grasp of the ideological justification for a free
market exchange economy without overnment intervention.

• There have two consumers, You and Me
• There are two goods being produced by the private sector firms, X and Y
• There are two factors of production used my firms, L and K

Okay:

Using the usual graphs of microeconomic analysis (e.g. budget lines and
indifference curves, isoquant curves and production functions, the
Edgeworth Box, contract curve, and the Production Possibility Schedule,
or Frontier for the economy), work through the steps to SHOW that in a
competitive equilibrium for a two consumer, two-good, and two-factor
market the conditions under which:

Maximum welfare is achieved (supply equals demand-consumers maximize satisfaction and producers minimize costs).

That is: show how:

(a) each of the MRSs between the two goods of the two consumers are equal,

(b) the MRS of each consumer is equal to the price ratios of the two goods,

(c) each of the MRSs is equal to the ratio of the MCs of producing the
two goods, AND equal to the MRT of the production possibility curve.

When you have done this, you should be able to understand that in a free
exchange market for a PRIVATE GOOD, in equilibrium, MRS (of consumer
#1) = MRS (of consumer #2) = MRT (the marginal rate of transformation).
That is, the opportunity costs between the two good X and Y in our
HEADS is the same as the costs implicated by the society as a whole in
terms of the market prices.

PS: when all this happens, you are maximizing consumer and producer
surplus, and therefore total welfare in the market. If all markets work
this way, you maximize welfare in the total economy!

(6)

Why do we say that the Second Fundamental Theorem of Welfare Economics
helps to justify governmental attempts to alter income distribution with
tax and spend policies as long as markets can work normally once the
tax and spend policies are in place?