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Microeconomics Tutorial Solutions

The central problem of public choice is determining each individual's desired level of public goods as these can vary between individuals based on income and tax system. Arrow's Impossibility Theorem suggests that achieving decisiveness, unrestricted domain, transitivity, independence of irrelevant alternatives, responsiveness, and non-dictatorship in collective decision making is impossible. Lindahl equilibrium occurs when the sum of tax prices equals the marginal cost of public good production, resulting in Pareto efficiency. Single-peaked preferences have a unique optimal outcome for individuals, while multiple-peaked preferences can have multiple optimal outcomes as movement away from the most preferred alternative can initially decrease but later increase utility.

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87 views2 pages

Microeconomics Tutorial Solutions

The central problem of public choice is determining each individual's desired level of public goods as these can vary between individuals based on income and tax system. Arrow's Impossibility Theorem suggests that achieving decisiveness, unrestricted domain, transitivity, independence of irrelevant alternatives, responsiveness, and non-dictatorship in collective decision making is impossible. Lindahl equilibrium occurs when the sum of tax prices equals the marginal cost of public good production, resulting in Pareto efficiency. Single-peaked preferences have a unique optimal outcome for individuals, while multiple-peaked preferences can have multiple optimal outcomes as movement away from the most preferred alternative can initially decrease but later increase utility.

Uploaded by

Mithlesh Prasad
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

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EC302: Microeconomic Analysis


Semester 2, 2019
Tutorial 4 Solution (Week 5)
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1. Discuss the central problem of public choice or collective decision-making.

The central problem is ascertaining the desired level of public goods of each individual.
It is difficult as different individuals have different levels of government expenditure. The
preferred level depends upon on person’s income and tax system.
2. Discuss the basic properties of individual preferences.
a) Completeness/Comparability: Individual should be able to make a decision: for example,
individuals should be able to compare two combinations of public goods.
b) Transitivity: The individual choices must be consistent. If Good X is preferred to Good Y
and Good Y is preferred to Good Z, then Good X should be preferred to Good Z.
c) Non-satiation: This implies that the individuals are never satisfied or collectively the
marginal utility never becomes zero for all goods.
d) Convexity: This implies that individuals prefer some mean combination of extreme
options. They like a balance in consumption

3. Discuss some of the problems with Median Voter theorem.


a) Majority of the individual may not favor the result of the decision making process.
b) The outcome might not result the efficient level of public good.

4. Discuss the Arrow’s Impossibility theorem.

This theorem helps us think about good decision making rule and suggest six ethical
criteria.
a) Decisiveness: It must be able to rank all possible outcomes. Providing a preference ranking
for all possible contingencies for the society.
b) Unrestricted domain: It must produce a ordering over all outcomes regardless of the
nature of voters’ preferences, including multi-peaked preference.
c) Transitivity: It should provide a consistent ranking all possible alternatives. Absence of
transitivity would mean we get into cycling/voting paradox.
d) Independence of irrelevant alternatives: The collective decision rule’s ranking of Xa and
Xb should depend only on its ranking of Xa and Xb and not on other alternatives. Decision
should not depend on how these alternatives are ranked relative to any other.
e) Responsiveness: It must be responsive to individual’s preferences. If every individual
prefers Xa to Xb, and no one prefers Xb to Xa, then collective decision making should
indicate that Xa is preferred to Xb.
f) Non-dictatorship: The preferences of many voters cannot be the preference of only one
person.
The theorem suggest that in practice, all six these criteria is impossible to apply in a
decision/voting system. Thus, collective decision making in practice is not easy, consistent
or rational.
5. What is meant by Lindahl equilibrium?

It is the level of public goods provision in which the sum of the tax prices equals the
marginal cost of production. Lindahl equilibrium is Pareto efficient, there is no incentive
for people for correctly reveal their preferences.
6. How does multiple-peaked preferences differ from single-peaked preferences?

Single-peaked preferences imply that individuals behave as if a unique optimal outcome


exists for them. The further away from their optimal, either in the positive or negative
direction, the worse things are. On the other hand, multiple-peaked preferences imply
that people who move away from their most-preferred alternative become worse off at
first but eventually become better off as the movement continues in the same direction.

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