DSE 2008 Q 35

[Shefali]

Pls help me with q35....series 2..thnkz

[mrittik]

very easy approach.....subsidy 1 to 1 & Tax of 1 on 2.....

[Shefali]

pls elaborate mrittik..why so

[mrittik]

an easy approach u may find that the Initial utilities are changed....where person 2's utility was 2, after allocation it stands only 1....so if she is taxed then only her utility decreased....next for person 1's utility increased only for subsidy....understood?

[Granpa Simpson]

The initial endowments are (0,1) and (2,0)..initially the utility of agent 1 is 0 and for agent 2 utility is 2..now look at the initial level of utility transfer, no agent can be made better off without keeping the other agent at the same utility level unless a pre-trade condition is imposed...in order to make agent 1 better off he/she needs atleast positive amount of both goods, but such transfer will make 2 worse off...so a policy has to be made in such a manner that 2 will refrain himself from consuming the good which he is giving off..so he will have to be taxed for good 1 as to reach the point (1,1) and (1,0) he will have to leave 1 unit of good one which can be done only if he is taxed for consuming good 1, u can compare (1,1) and (0,1) and see that it is a competitive equilibrium if 2 is taxed on good 1.
Subsidies to both will not induce 2 to refrain from consuming 1.
Tax on both will not encourage 1 to get more of one and hence (1,1) cannot be reached.
Subsidy on 1 to person 2 will not encourage 2 to give off good 1.
so c seems to be the best choice.

[Granpa Simpson]

without such a transfer (1,1) and (1,0) is not a competitive equilibrium as Agent B is getting worse off as compared to the initial utility level of 2.

[Shefali]

Thanx mrittik and subhayu
Subhayu v well explained

[Granpa Simpson]

Ur most welcome Shefali..my pleasure..!!!!