Homework 16: Key

1.	(Frank, Ch.16) Bert has an initial endowment consisting of 10 units of clothing and 10 units of food. Ernie's endowment consists of 20 units of clothing and 10 units of food. Represent these initial endowments in an Edgeworth box for exchange. (Put clothing on the horizontal axis. Note: the axes just give you a place to draw your Edgeworth box; use only as much of each axis as you want in order to construct the box.)

2.	Electric utility regulation has often resulted in high-volume consumers (H) paying lower prices for their additional consumption of electricity than do low-volume consumers (L). To illustrate the results, consider a consumer from each group, H and L, both of whom consume two goods, electricity (E) and other goods (G).
	a..	Draw an Edgeworth box for exchange which illustrates their situation. Put electricity on the horizontal axis, and use the lower lefthand origin for H, the high-volume consumer.
	b.	Add tangency lines to your indifference curves to contrast the MRS for the two consumers. Compare BLah to BLaL.
	c.	What sort of exchange between these two consumers could raise the welfare of both? Briefly explain why, and use your diagram to illustrate the results of your recommended exchange. H exchanges electricity for other goods with L, since H places a lower relative value on electricity than L does. Answer key checklist: (1) Did you (correctly) label your axes, origins, and curves? (2) Did you choose a common allocation point for both isoquants/indifference curves? (3) Did your isoquants/indifference curves continuously slope downward?

3.	Consider the Edgeworth box for exchange depicted in the diagram to the right. The two consumers, A and B, are initially at allocation i in the diagram. CC denotes the contract curve.
	a..	What quantities would you estimate make up the initial allocation for each consumer? XA= 30 YA= 90 XB= 90 YB= 30
	b.	Which of the labeled allocation(s) would be considered Pareto optimal? a...g
	c.	Shade in the area which contains allocations which are Pareto superior to allocation i.
	d.	Which of the labeled allocation(s) would be considered Pareto superior to allocation i? c,d,e,m (j is Pareto equivalent, but you don't lose any credit if you include it)
	e.	Illustrate the resultss of the the consumers moving to allocation h. Would you be surprised if this happens, given their initial allocation? Why or why not? Yes--both end up on lower indifference curves.
	f.	Illustrate the results of an exchange which moves the consumers to (1) allocation m and (2) allocation e.

4.	Answer the following questions about the online reading, "How to Ration Water" (http://faculty.oxy.edu/whitney/xaccess/ec250/v_water.htm):
	a.	Explain why the plan adopted for the allocation of water in Marin County will not lead to exchange efficiency. Use an Edgeworth Box diagram to illustrate your answer (put water on the horizontal axis and other goods on the vertical axis). Both households start out with the "flat maximum number of gallons per day." With 37 gallons apiece, some users will value additional water more highly than others. In the diagram to the right, at point a, the low-valued user (lo) has a lower MRS than the high-valued user (hi). Answer key checklist: (1) Did you show a single, common initial point within your Edgeworth box that set the consumption for both consumers? (2) Did your initial consumption allocation give you a lens? (Your lens will be the reverse of mine if you reversed the origins of the high-value and low-value water users.)
	b.	Explain how Friedman's proposal can make at least some better off without making anyone else worse off. In your diagram, show how his proposal can raise the welfare of both consumers. Friedman's proposal essentially lets users sell off excess water to users who value it more highly. That could allow the users here to move to point , where both have higher utility, and their MRS's are equalized. Answer key checklist*: Did you move to new indifference curves within the lens you set up in part a?