There are two individuals, A and B, and two commodities, Commodity 1 and Com- mo
ID: 1104848 • Letter: T
Question
There are two individuals, A and B, and two commodities, Commodity 1 and Com- modity 2. The distribution of output in two states of the economy, State 1 and State 2, is shown in the following table: State 1 State 2 Individual Commodity Commodity 2 Commodity 1 Commodity 2 2 0 0 0 0 2 Assume that the preferences of A and B are given as follows: A: (1 unit of Commodity 1 and 1 unit of Commodity 2) is preferred to (2 units of Commodity 1 and 0 units of Commodity 2) is preferred to (1 unit of Commodity 1 and 0 units of Commodity 2). B: (1 unit of Commodity 1 and 1 unit of Commodity 2) is preferred to (O units of Commodity 1 and 2 units of Commodity 2) is preferred to (0 units of Commodity 1 and 1 unit of Commodity 2). (a) Is State 1 better than State 2 using the compensation principle? Explain. (b) Is State 2 better than State 1 using the compensation principle? Explain. (c) What implication do these findings have for the compensation principle? (Note: The compensations is these two cases are different from what we have usu- ally done in such cases.)Explanation / Answer
According to question individual's preference:
case 1:
1
case 2:
since, case 1 is prefered to case 2 to according to the preference of the individual A and B, both in case of state 1 and state 2 does not satisfy the welfare motive when the first preference is taken in account.
when we look into the second preference of individual we see that the individual A satisfies the preference in state1 and individual B satisfies the preference in state 2.
Third preference table case 3:
According to kaldor and hicks welfare approach,when an individual compensates to make someone betteroff without making itself worseoff,where one individual do not looses anything in making other better off. It is called as compensation principle where gainers compensate loosers to make them better off without any loss and hence the welfare is being done.
(a). Neither state 1 is better nor the state 2 because when we will consider the compensation principle according to the preferences of the individuals,in both states it is not satisfied.
Say,
According to first preference if individual A compensates 1 unit of commodity 1 to individual B to make it better off it will make itself worseoff. And if the individual takes its second preference if both the individual A and B compensates one -one unit of commodity one and commodity two in both the states respectively it will achieve its first preferece and individual will become betteroff without making each other worseoff.
So, it can be said from the above informations given that both the states can not be called in a better position. Both of them will be better or both of them will not be better only when preference of individual is considered.
(b) Same explanation as of (a).
(c). When we talk about the compensation principle we will have to keep in mind that when any individual is compensating for a welfare motive both the individual should gain.
Example:
Contruction of a bridge. Individual X are the business person and Individual Y are the poor people living around the contruction area. The individual X is gaining from the construction of bridge which help in trading nad the poor sections are compensated by the bussiness persons for the trouble they are getting due to construction of the bridge. So, in both cases they are gaining not too much better off but little without any loss to the business persons.
Therefore, compensation principle follows the rule of making betteroff without making one worseoff.And here in the second preference of both individual they are making each other betteroff without making onesekf worseoff in two different states.
individual commodity1 commodity 2 A 1 1 B 11