Question

2.

Imagine a society made up of two kinds of people-the Xs and the Ys. There
are an equal number of Xs and Ys. The society is considering three policy
actions: a, b, and c. Each individual in the society cares only about his or her
personal wealth.
• Under action a, all members of society have wealth 10.
• Under action b, the Xs each have wealth 11 and the Ys each have
wealth 12.
• Under action c, the Xs each have wealth 15 and the Ys each have
wealth 9.
(a) Define a policy as an action and a budget balanced transfer scheme. All
budget balanced transfer schemes are feasible. People have quasi-linear
preferences. Which policies are Pareto efficient?
(b) Call the transfer scheme where no one gets any transfer to. Which of the
following is true:
i. (a, to) Pareto dominates (b, to).
ii. (b, to) Pareto dominates (a, to).
iii. Neither of these two policies Pareto dominates the other.
(c) Identify a normative framework that would be in favor of the move from
(b, to) to (c, to) and explain why.
(d) Identify a normative framework that would be opposed to the move
from (b, to) to (c, to) and explain why.

Answer 1

(a) In this scenario, a policy refers to one of the three actions being considered: a, b, or c. A budget balanced transfer scheme involves redistributing wealth between the Xs and the Ys in a way that maintains a balanced budget. With quasi-linear preferences, where individuals only care about their personal wealth, the policy that maximizes total wealth in society while maintaining a balanced budget is considered Pareto efficient.

In this case, policy c, where the Xs have wealth 15 and the Ys have wealth 9, is Pareto efficient as it increases the overall wealth in society without violating the budget balance.

(b) If the transfer scheme results in no one receiving any transfer (to), it means there are no wealth redistributions in place. In this case:

i. (a, to) does not Pareto dominate (b, to) since policy b has higher wealth for both Xs and Ys.

ii. (b, to) Pareto dominates (a, to) since it offers higher wealth for both Xs and Ys.

(c) A normative framework favoring the move from (b, to) to (c, to) could be one that prioritizes equity or the overall welfare of society. By implementing policy c, the wealth disparity between Xs and Ys is reduced, leading to a more equal distribution of wealth. This framework recognizes the importance of addressing inequality and promoting social cohesion.

(d) A normative framework opposing the move from (b, to) to (c, to) could be one that emphasizes individual property rights and economic freedom. This framework may argue that policy c, which redistributes wealth from the Xs to the Ys, infringes upon the rights of the Xs to keep the wealth they have earned. It may prioritize the principle of allowing individuals to keep what they earn through their own efforts.