University of California Economics 100A
Department of Economics Professor K. Train
Problem Set #2
I. Consumer Surplus and Compensating Monetary Value
Suppose a person’s demand curve for cigarettes is:
c = 100 − 10 Pc where c is packs of cigarettes per month
and Pc is the price per pack of cigarettes
1) If the price of cigarettes $1 per pack, what is this person’s consumer surplus?
2) If the government taxes cigarettes such that the price paid by this person rises to $3 per
pack, what is the compensating monetary value of this change?
II. Compensating Principal
We subsidize clothing for Raggedy Andy by giving him vouchers to be used in buying clothes.
Each voucher is worth $10 and can be used in purchasing one item of clothing. We allow him
an unlimited supply of vouchers. The price of clothing is $15 per item, and so these vouchers
lower the price that Andy pays to $5 per item. With these vouchers, Andy buys 10 items of
clothing. The clothing merchants submit the vouchers to us, which we redeem (that is, we pay
the merchants $10 for each voucher they give us). We pay for the program by taxing Slick Sly
$100.
Does this program result in a better allocation by the compensation principal? Show your
answer graphically. (This is a simple problem; don’t make it complex.)
Page 1 of 5
, University of California Economics 100A
Department of Economics Professor K. Train
III. Consumption Economy
1) Consider the following Edgeworth Box for consumption of two goods by Ross and
Rosa.
Consider allocations b-f. Which allocation(s)
a) are better for Ross than “a” (ignoring Rosa)?
b) are better for Rosa than “a” (ignoring Ross)?
c) are worse for both Ross and Rosa than “a”?
d) are better for both Ross and Rosa than “a”?
e) are Pareto superior to “a”?
f) can be reached through free (voluntary trade) from “a”?
g) can be reached through free trade from “a,” and once they have been reached, no
further mutually beneficial trade is possible?
h) are Pareto optimal? (Be careful!)
i) are Pareto optimal but not Pareto superior to “a”?
j) are better than “a” by the compensation principal?
Page 2 of 5
Department of Economics Professor K. Train
Problem Set #2
I. Consumer Surplus and Compensating Monetary Value
Suppose a person’s demand curve for cigarettes is:
c = 100 − 10 Pc where c is packs of cigarettes per month
and Pc is the price per pack of cigarettes
1) If the price of cigarettes $1 per pack, what is this person’s consumer surplus?
2) If the government taxes cigarettes such that the price paid by this person rises to $3 per
pack, what is the compensating monetary value of this change?
II. Compensating Principal
We subsidize clothing for Raggedy Andy by giving him vouchers to be used in buying clothes.
Each voucher is worth $10 and can be used in purchasing one item of clothing. We allow him
an unlimited supply of vouchers. The price of clothing is $15 per item, and so these vouchers
lower the price that Andy pays to $5 per item. With these vouchers, Andy buys 10 items of
clothing. The clothing merchants submit the vouchers to us, which we redeem (that is, we pay
the merchants $10 for each voucher they give us). We pay for the program by taxing Slick Sly
$100.
Does this program result in a better allocation by the compensation principal? Show your
answer graphically. (This is a simple problem; don’t make it complex.)
Page 1 of 5
, University of California Economics 100A
Department of Economics Professor K. Train
III. Consumption Economy
1) Consider the following Edgeworth Box for consumption of two goods by Ross and
Rosa.
Consider allocations b-f. Which allocation(s)
a) are better for Ross than “a” (ignoring Rosa)?
b) are better for Rosa than “a” (ignoring Ross)?
c) are worse for both Ross and Rosa than “a”?
d) are better for both Ross and Rosa than “a”?
e) are Pareto superior to “a”?
f) can be reached through free (voluntary trade) from “a”?
g) can be reached through free trade from “a,” and once they have been reached, no
further mutually beneficial trade is possible?
h) are Pareto optimal? (Be careful!)
i) are Pareto optimal but not Pareto superior to “a”?
j) are better than “a” by the compensation principal?
Page 2 of 5
