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Consider a country with only two residents, Jack and Jill. Both have the same utility function: U=Y, where U is utility and Y is
Consider a country with only two residents, Jack and Jill. Both have the same utility function: U=Y, where U is utility and Y is income. The country is considering two policies that would result in the following incomes for its two residents. Jack Jill POLICY 1 $100 $4 a) Which policy would be preferred under the Kaldor-Hicks criterion? POLICY 2 $81 $16 b) Which policy would maximize social welfare under a utilitarian social welfare function? Explain. c) We will generally assume a utilitarian social welfare function in this course. But that is not the only possible social welfare function. Another function that is sometimes used is a Rawlsian social welfare function, under which the goal is to maximize the utility of the worst off member of society. Formally, SW = min(U(Y1), U(Y2). ... U(YN)). Which policy would maximize a Rawlsian social welfare function? Explain. d) Suppose instead that the utility functions of the two individuals in society were U = Y, where U is utility and Y is income. If social welfare is the sum of the utilities of individuals in society and if redistribution results in efficiency loss, what is the socially optimal amount of redistribution in this case? e) Suppose now that we don't know what the utility function is, but we do know that both individuals have the same utility function and that the marginal utility of income is declining. Would we prefer Policy 1 or Policy 2? Explain. f) Now suppose we are choosing instead between the following two policies: Jack Jill POLICY 1 $100 $4 What would your answer to (e) be in this case? Explain. POLICY 2 $88 $16
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