beverages available: coffee and milk. Kalia is entirely indifferent between drinking coffee or

milk, she likes both equally. Kanoa is, instead, extremely picky: he only likes coffee and milk

mixed together in fixed proportions. He doesn't like milk if it's without coffee, and he doesn't

like coffee if it's without milk.

Kanoa starts with an endowment of 10 gallons of milk and 2 gallons of coffee. Kalia starts with 2

gallons of milk and 5 gallons of coffee.

a) Describe the economy graphically by plotting Kanoa and Kalia's indifference curves. Is

the initial allocation efficient? If it isn't, show the region that contains all the superior

allocations that can be reached through mutuallybeneficial trades.

b) Show in a graph, how Kanoa and Kalia can become better off by trading, until they

exhaust all the gains from trade.

c) Define and show the Contract curve in a graph.

d) Would the equilibrium allocation that you found be different if Kanoa had an increased

bargaining power? Under what conditions, would the bargaining power be

irrelevant/relevant?