Pareto Efficiency

Consider an economy with two people, Nancy and Roger, and two commodities, tea and biscuits. Currently, Nancy and Roger would both be willing to substitute two cups of tea for one biscuit. Further, if the economy were to produce one less cup of tea, the resources released from tea production could be used to produce three more biscuits.

a.What is the value of the marginal rate of substitution and the marginal rate of transformation?

b.Is the allocation in this economy Pareto efficient? Show graphically by drawing the indifference curve and the production possibilities schedule into the figure below. If not, should there be more tea or more biscuits?

c.Explain why an economy in which airlines charge different passengers, different prices for the same flight is not Pareto efficient;when all passengers have the same preferences.

d.Consider an economy which produces two goods, cars and shirts. Explain why if a tax is imposed on the consumption of cars but not on shirts, the economy will not be efficient.

e.Is it always better if the government intervenes when markets fail? Why (not)?