Consider two consumer, LaTeX: h=1,2h = 1 , 2, with preferences LaTeX: U=lnleft(x^h ight)-frac{z^h}{s^h}U = ln ?
Question:
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Consider two consumer, LaTeX: h=1,2h = 1 , 2, with preferences LaTeX: U=\ln\left(x^h ight)-\frac{z^h}{s^h}U = ln ? ( x h ) ? z h s h, where LaTeX: x^hx h is consumption, LaTeX: z^hz h is income, and LaTeX: s^hs h is skill level.Assume that LaTeX: s^1=1s 1 = 1 and LaTeX: s^2=2s 2 = 2.
(i) Consumer 1 is allocated consumption LaTeX: x^1=1x 1 = 1 and income LaTeX: z^1=1z 1 = 1. Consumer 2 is allocated consumptionLaTeX: x^2=2.718x 2 = 2.718. What is the maximum income 2 can earn before incentive compatibility is violated?
(ii) Combine the incentive compatibility constraint and the aggregate resource constraint (LaTeX: z^1+z^2=x^1+x^2z 1 + z 2 = x 1 + x 2) to solve for LaTeX: z^1z 1 and LaTeX: z^2z 2. If LaTeX: x^1=2.7183x 1 = 2.7183 and LaTeX: x^2=7.3891x 2 = 7.3891, what is the implied value of LaTeX: z^1z 1?
(iii) Assume social welfare is given by LaTeX: W=U^1+U^2W = U 1 + U 2. Using the answers to (ii) write social welfare as LaTeX: W=\beta^1\ln\left(x^1 ight)+\beta^2\ln\left(x^2 ight)-\gamma\left[x^1+x^2 ight]W = ? 1 ln ? ( x 1 ) + ? 2 ln ? ( x 2 ) ? ? [ x 1 + x 2 ]. What is the value of LaTeX: \beta^2? 2?
(iv) What is the optimal value of LaTeX: x^1x 1?
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