Georgia ECON 4100 – Economics, Philosophy

Econ 4100, Economics, Philosophy and Public Policy, Spring
2017
Problem Set 1, Wednesday, February 01, 2017
Due Wednesday, February 8, 2017

Purpose of this problem set: get yourself familiar with i)
the economists’ interpretation of individual welfare and the assumptions
embedded there, ii) the Pareto principle and Pareto efficiency, and iii) the
normative aspects of market systems (we have not discussed these aspects yet);
the main materials related to this problem set are covered in the weeks 3 and
4.
1. In Question 1 of PS 1, you worked the details of the two
policies that intended to help individuals in need. In particular, you presented reasons
suggesting that cash transfers are always “at least as good” for their
recipients as in-kind transfers, and are sometimes better.
a. Explain how your reasoning and suggestion presented in
Question 1 of PS 1 are based on the economist’s interpretation of a consumer’s
welfare as preference satisfaction, and the underlying assumptions there.
b. However, government policies often involve in-kind
transfers: this is the case for food, housing, education, legal services,
health care, and many other goods, and in-kind transfers are often much more
popular than cash transfers. Can you
think of possible reasons that the government chooses in-kind rather than cash
transfers in such cases? Make sure that
you spell out your assumptions in the process of presenting your answers.

2. Recall the two policy options discussed in Summers’ memo:
Option A: the status quo
Option B: Moving the dirty industry from the developed
country (DC) to the less developed country (LDC) and paying an appropriate
compensation to the LDC by the DC
c. State the ranking of the two policy options by DC and by
LDC according to the memo.
d. Is the Pareto principle applicable to the situation that
you stated in c? If no, explain; if yes,
which version of the principle (Pareto principle or/and weak Pareto principle)
is applicable?
e. According to your stated ranking in c, between the two
policy options, which one is Pareto efficient and which one is not Pareto
efficient? Explain.
3. This question is based on one of your week 3’s reading: Daniel
M. Hausman and Michael S. McPherson. 1997.
Beware of Economists Bearing Advice.
Policy Options 18 (7): 16-19.
f. In illustrating the economist’s argument for why welfare
benefits should be provided in cash rather than in in-kind,Hausman and McPerson
identify three main assumptions behind the argument. What are the three main assumptions behind
the economist’s argument that they identify?
g. In their discussion in the section, “Is the goal to
increase well-being?”, what caution and complication should we be aware in
articulating the goal(s) of the policy?

4. You and your sister are dividing a cake. Your sister is always craving for more food:
she always prefers more to less. You, on
the other hand, prefer more to less up to 1/3 of the cake; beyond that, you can
still eat it but will not derive any extra utility. Consider the following divisions:
?:your sister has the whole cake and you have none.
?:you have the whole cake and your sister has none.
?:your sister and you share the cake equally.
?:you have 1/4 of the cake and your sister has 1/2 of the
cake.
?:you have 1/3 of the cake and your sister has 2/3 of the
cake.
h. Identify those divisions that are Pareto efficient. Explain your answers.
i. Identify those divisions that are weakly Pareto
efficient. Explain your answers.
5. Consider four states, A, B, C and D. The utility numbers
of the four states for the individuals are given below (there are three
individuals in the society):
individual 1 individual
2 individual 3
A 5 2 1
B 0 5 6
C 3 3 5
D 4 5 6
j. Suppose all four states are feasible. Identify those states that are
j.1 Pareto efficient j.2
weakly Pareto efficient.
k. Suppose D becomes infeasible (so that there are three
feasible states). Identify those states
that are
k.1
Pareto efficient k.2 weakly Pareto
efficient.