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Pareto Efficiency and Social Decision Mechanisms

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14 views7 pages

Pareto Efficiency and Social Decision Mechanisms

Uploaded by

vinitkumarofficial
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Serial no.

3632

Q1a

UR(10,0) = UR(0,10) and UM(10,0) = UM(0,10)

e1 and e2 are Pareto efficient allocations (2 diagram + 2explanation+ 2contract curve)

the allocation e1 and e2 are equitable because swapping the bundle between the consumers will not
make either of the consumers better off. (1.5)

contract curve consists of only two points e1 and e2 in the Edgeworth box.

Q1. (b) See Varian Figure 31.8 (2.5 regardless)


p.596 Varian : continuity, convexity or more general condition consumers are small relative to the size of
the market. Condition that we need to impose on preferences to ensure a unique and interior solution is
that preferences should be convex so that we get strictly convex ICs. If both agents have convex
preferences we can draw a straight line between the two sets of preferred bundles that separates one from
the other. The slope of this line gives us the relative prices, and any endowment that puts the two agents
on this line will lead to the final market equilibrium being the original pareto efficient allocation. (2.5)
1c. Ideally we would want our social decision mechanism to satisfy the following properties:
1. Given any set of complete, reflexive and transitive individual preferences, the social decision
mechanism should result in social preferences that satisfy the same properties.
2. If everybody prefers alternative x to y, then the social preferences should rank x ahead of y.
3. The preferences between x and y should depend only on how people rank x versus y, and not on
how they rank other alternatives.
Although these properties seem eminently plausible, it can be quite difficult to find a mechanism that
satisfies all of them. Arrow’s Impossibility Theorem suggests that if a social decision mechanism satisfies
properties 1, 2 and 3, then it must be dictatorship i.e. all social rankings are the rankings of one individual.
If we want to find a way to aggregate individual preferences to form social preferences, we will have to
give up one of the properties of a social decision mechanism described in Arrow’s Theorem. We cannot
satisfy all the properties simultaneously.
(Total 5, for incomplete answer 2)
Q2a. It can have multiple answers depending on production function. S&N p 412 & 413 (5, mark
leniently and open to all interpretation)

Q2. (b)
i. Rank-1 to best and rank-4 to worst going from top to bottom.
Scores: p= 1+4+3+1+3=12
q=2+3+2+3+4=14
r=3+2+4+2+1=12
s=4+1+1+4+2=12
Least liked option is ‘q’ which has the highest score since the worst outcome is assigned a
higher numerical value. There is a tie between the rest of the alternatives.
(Total 5= 1m each for each alternatives score; 1m final winner)

ii. Pairwise voting


p vs q- p wins since 3 individuals out of 5 i.e. A, D & E rank p ahead of q.
p vs r- p wins since 3 individuals A, C & D rank p ahead of r.
p vs s- s wins since 3 individuals B, C & E rank s ahead of p.

Final winner- ‘s’

(Total 5= 2m step 1 + 1m step 2 + 1m step 3 + 1m final winner)

iii. Voting outcome can be manipulated depending on how we present alternatives for pairwise
voting.
(Total-2.5m)

Q3. (a) See Varian Section 36.6: The Free Rider problem

(Total 7.5= 5m for explanation; 2.5m for diagram)

(b) i. Average price that consumer is willing to pay: 15q+9(1-q) (1m)


In equilibrium, 15q+9(1-q) ≥ 12.50 => q ≥ 7/12 or 0.583 (1m)
Market will be in equilibrium if q lies between 7/12 and 1. (1m)
(2m properly labelled diagram
accept all logical answers)

ii. Producers will produce low quality sharpeners since they have lower production cost. If all
producers produce low-quality output, cost will be 12.50. Since willingness to pay for the
consumers is 9, the only equilibrium is zero production of either quality.

(3m for correct answer zero production and 2m for justification)

Price 15q+9(1-q)
Q4ai 𝛱ℎ = 150𝑥 − 5𝑥 2 and 𝛱𝑓 = 90𝑦 − 2𝑦 2 − 4𝑥𝑦 (1 each)

x*= 15 and y* = 7.5 (0.5)

ii. 𝛱𝑚 = 150𝑥 + 90𝑦 − 5𝑥 2 − 2𝑦 2 − 4𝑥𝑦 (3)

x* = 10 and y* = 12.5 (2)

4bi (1 + 1) WA = (1 + 0) WA (1.5)

(2 + 1) WS = (2 + 0) WS (1.5)

rA = (1/2)WA and rs = (1/3)WB (2)

ii. rA + rB = 75<80 they won’t be able to procure the water filter (4)

Justification: first order and the second order condition pp. 697-98 Varian (1)
25
Q5i. AC = +2 (1)
𝑄

25
Slope of AC = (-𝑄2) natural monopoly (1,3)

ii. Q* = 24.5, p* = 51 and profit = 1175.5 (2,2, 1)


iii. yes government should intervene. Justification for regulation S&N pp468 &469. (5)
iv. Post regulation with marginal cost pricing, MC = P =2 and output = 49 and profit = -24.99
profit with cross subsidization = 1150.5 (1,2,2)
[Link] 𝜋1 = (140 − 𝑄1 − 𝑄2 )𝑄1 − 30𝑄1 , 𝜋2 = (140 − 𝑄1 − 𝑄2 )𝑄2 − 30𝑄2 (1 each)

𝑄1 * = 𝑄2 = 90, p = 120, 𝜋1 = 8100 = 𝜋2 (1, 1, 1)

270− 𝑄1
ii. 𝜋1 = (300 − 𝑄1 − ( )) 𝑄1 − 30𝑄1 (2)
2

𝑄1 * = 135, 𝑄2 * = 67.5, p = 97.5, 𝜋1 = 9112.5 & 𝜋2 = 4556.25 (1, 1, 1)

iii.
Price with Stackelberg model (97.5) is less than that with Counot’s (120). Since price in the Stackelberg
model is lower so the total market output and consumer surplus is higher. At the same time profit of the
first mover is higher. (1+2+2) deduct 1 for not drawing isoprofit curve 0 if neither coordinate nor isoprofit

6b. let firm 1 will be located at ¼ and firm 2 at [Link] P1 be the price of firm 1 and p2 be for firm 2.
let X be the location of the consumer who is indifferent between buying from firm 1 and firm 2.

P1 + 2(1-1/4) = P2 +2(1-X)

X = (P2-P1)/4 +5/8 = Q1 &

Q2 = 1 - (P2-P1)/4 +5/8 = 3/8 + (P1 – P2)/4

P1 = 13/6 & P2 = 11/6

Q1 = 13/24 & Q2 = 11/24, 𝜋1 = 169/144 and 𝜋2 = 121/144 (2,2,1)

Q7a. Definition of Nash equilibrium, S&N or Osborne, 2 NE, (U,L) & (D,C) (1+(4= explanation 2 +2
answer)) 1 for if Nash equilibrium is mentioned in payoffs (3,3) & (4,2)

b. definition of dominated actions, Osborne DEFINITION 43.2 & 45.1 OR an intuitive explanation is
should also be acceptable. Both the actions R and M are weakly dominated. (1+4)

c. after removing the dominated actions, the mixed strategy, (p, 1-p) = (1/3, 2/3) and (q, 1-q) =
(2/3, 1/3) (1+4)
140− 𝑞1
d. 𝑞2 = best response function of firm 2
2

140− 𝑞1
𝜋1 = (140 − 𝑞1 − ( 2
))𝑞1

𝜋1𝑎𝑐𝑐 = 2450 (2)

𝜋1𝑑𝑒𝑡 = 2√𝐾2 (140 − 2√𝐾2 )

𝐾2 = 105.0625 (+3)

8a. (1,1,1) will be the only Nash equilibrium in this game. One can start with any number between
and 1 and 6, the players will have an incentive to announce a lower number and increase their
payoffs. At (1,1,1) there is no incentive to deviate. OR the explanation given in the solution book
should also be acceptable. (5)

b. S&N chap 14 p 506 (4+1 diagram)

ci. 𝜋1 = 70𝑞1 − 𝑞12 − 10𝑞1 , 𝑞1∗ = 30 𝑎𝑛𝑑 𝑝1∗ = 40 (2)


1 2
𝜋2 = 35𝑞2 − 𝑞
2 2
− 10𝑞2 , 𝑞2∗ = 25 𝑎𝑛𝑑 𝑝2∗ = 22.5 (2)
(1)

OR there are other possible diagrams please consider them also

1 1
40 ( 1 + 𝑒 ) = 22.5( 1 + 𝑒 )
1 2
1
40 (1+ )
𝑒2
22.5
= 1 >1 the elasticity will be higher in market 2 than in market 1 (2,2,1)
(1+ )
𝑒1

Common questions

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A natural monopoly arises due to significant cost advantages that allow a single firm to supply the entire market more efficiently than multiple firms. Without regulation, such monopolies may exploit market power to set prices above competitive levels, reducing social welfare. Government regulation can introduce pricing constraints, such as marginal cost pricing, resulting in increased output and reduced prices, potentially leading to negative profits without cross-subsidization. Yet regulation aims to balance the monopoly's efficient operation and consumer welfare .

Nash equilibria impact market competition by defining stable states where firms adopt strategies best responding to rivals, minimizing incentives to change strategy unilaterally. In strategic planning, it informs firms' understanding of stable competitive interactions, guiding decisions on pricing, product launch, and resources allocation. It stabilizes expectations about rivals' actions, enabling more informed and consistent long-term planning and reducing strategic uncertainty in competitive markets .

In pairwise voting systems, the presentation order of alternatives can significantly influence outcomes. Manipulating the order can strategically change the pairs or sequence in which options are presented, thereby affecting coalitions or preference strengths. Such manipulations can lead to outcomes that do not genuinely reflect the voters' preferences, thus undermining the system's integrity and leading to decisions that are less representative or fair .

In the context of an Edgeworth box, allocations e1 and e2 are Pareto efficient because no reallocation can make any individual better off without making someone else worse off. They are considered equitable because swapping the bundle between consumers does not improve the situation for either, implying a balance where preferences are met optimally for both parties involved, as depicted by the contract curve that only passes through e1 and e2 .

Nash Equilibrium provides a stable prediction where no player wants to deviate given the others' strategies, crucial in coordination games where firms must choose strategies that maximize their payoffs given expectations about rivals. In competitive markets, it helps predict outcomes where firms find mutually beneficial strategies, preventing unilateral deviations that can lead to inferior strategic positions, thus guiding strategic planning and competitive behavior .

Arrow’s Impossibility Theorem posits that no social decision mechanism can simultaneously satisfy all desirable properties, such as converting individual preferences into a complete, reflexive, and transitive social preference order, collective preference consistency if everyone prefers one option, and independence of irrelevant alternatives. This suggests that fulfilling these properties requires a mechanism to effectively be a dictatorship, making it impossible to have a fair and representative system for aggregating individual preferences into social choices without compromise .

Dominated strategies are those that result in worse outcomes than some alternative strategy, no matter what the opponent does. Identifying these strategies is crucial for rational decision-making as it helps simplify strategic choices by eliminating inferior options. This reduces the complexity of strategic interactions and can lead to more straightforward identification of equilibria, thus providing clearer predictive and prescriptive insights in competitive scenarios .

In the Stackelberg model, the leader firm sets its output first and anticipates the follower's response. This fosters a first mover advantage as the leader can influence the market price beneficially compared to the Cournot's simultaneous decision-making framework. Consequently, Stackelberg pricing typically results in lower equilibrium prices and higher total output but increases the leader’s profit due to the strategic commitment to its output level that the follower cannot ignore .

Consumer surplus captures the difference between what consumers are willing to pay and what they actually pay, reflecting consumer benefits in a market. In markets with quality differentiation, variations in surplus occur based on perceived quality differences, affecting demand elasticity. Higher consumer surplus can signal stronger demand and market power, potentially encouraging more firms to offer diverse quality levels to capture that value, impacting competition and market dynamics .

Multiple equilibria can arise when the production functions offer several solutions that satisfy equilibrium conditions, which can happen depending on the shape and properties of the production functions such as non-convexities or discontinuities. This introduces ambiguity and complexity into economic analysis, challenging the predictability and stability of economic outcomes, and necessitating a closer consideration of potential externalities and market externalities .

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