Conditions Cannot Be Improved without Affecting the Economic Position Question
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Exercises
1. Suppose that you have two daughters, Jane and Katie. You decided to buy them two toys:
a car and a computer game. Now you need to decide who will have which toy.
You know that Katie likes both the car and computer games and that Jane likes computer
games but is indifferent between having the car and not having it. Please find all the Pareto
efficient allocations (and explain).
2. Suppose that two firms, an incumbent and a potential entrant, compete in a market. If they
both operate, the resulting profits for the incumbent and the potential entrant are $30 million
and $5 million, respectively. If the potential entrant decides not to enter the market, the
resulting profits for the incumbent and potential entrant are $100 million and $0, respectively.
Assume that it is not an option for the incumbent to exit the market.
(a)
Which of the two possible outcomes (for the potential entrant to enter or not enter)
are Pareto efficient?
(b)
Now suppose there are side payments available. Which of the two possible
outcomes is Pareto efficient?
(c)
Is it possible that the incumbent will agree to pay for the introduction of side
payments?
(d)
Now suppose that side payments are allowed, but it costs $80 million in legal fees to
actually use them. Which of the two possible outcomes (for the potential entrant to enter or
not enter) are Pareto efficient allocations? (For simplicity, please assume no one is made
better off by the $80 million fees.)
3. Two firms, A and B, need to negotiate a contract. There are six possible contracts,
resulting in the following profits for the firms (in millions of $):
Contract
Firm As profit
1
2
3
4
5
6
100
80
40
45
10
75
Firm Bs profit
20
30
60
35
50
30
(a)
Determine which are the Pareto efficient contracts. Explain. Hint a graph can be
helpful.
(b)
Determine which are the Pareto efficient contracts if side payments are allowed.
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Tags:
computer game
efficient allocations
potential entrant
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