Economically Feasible Allocations and the Surplus

5.7 of The Economy 1.0 & The Economy #3

What does a reservation option entail?

-One’s next best alternative among all options in a particular transaction.

-Can be seen as a fallback option

What does a reservation indifference curve entail?

-A curve that shows allocations that are as highly valued as one’s reservation option.

Where would you find one’s economically feasible allocations?

-A new curve has spawned in! A reservation indifference curve, which begins at option Z. Above this curve and below the frontier, the economically feasible allocation can be seen.

Why does Angela’s reservation indifference curve diverge from her biological survival constraint?

-They share a point at Z, which infers that when Angela doesn’t work, she gets consumption from some other source - like the Government in the form of benefits

-When operating on the survival constraint, she is miserable. The more she works, the less free time she has.

-But her reservation indifference curve suggests that giving her more of the grain she makes exactly compensates the loss of free time.

How can Angela and Bruno benefit if such a deal is made, considering Bruno is a landowner and Angela is a farmer?

-As long as Bruno gets some of the crop, he does better than if no deal exists

-As long as Angela’s share makes her better off than if she took her reservation option, factoring work hours, she also benefits.

Given this graph, what hours will Bruno want Angela to work for in order to maximise his share of the grain?

-Because the option of her operating on her survival constraint is no longer viable, because of her reservation option, Bruno needs her to now operate on her reservation indifference curve.

-Thus, the way to find the new optimal amount of hours worked is by using MRT = MRS. This leads to Angela working less than before, and Bruno’s share falling, and Angela’s share rising.

Why does only Bruno benefit from this exchange, and not Angela?

-All of the joint surplus will go to him. Angela does not make any economic rent as she is operating on the same indifference curve as on her reservation option.