CALIFORNIA INSTITUTE OF TECHNOLOGY

Division of the Humanities and Social Sciences

Pareto Efficiency Examples

KC Border
January 2002
v. 2012.08.28::12.41

CobbDouglas Edgeworth box

Determine the Pareto efficient points in the Edgeworth box, where

u1 (x, y) = x1 y 1 ,

u2 (x, y) = x2 y 2 ,

where 0 < i , i , and the initial endowment is x

units of x and y units of y.
Consider the maximization problem
maximize x1 y 1 + (1 )(
x x)2 (
y y)2 .
As from 0 to 1 this traces out the Pareto efficient set. (More precisely x and y are person 1s
consumption level, and x
x and y y are 2s.)
For 0 < < 1, the first order conditions are
1 x1 1 y 1 (1 )2 (
x x)2 1 (
y y)2 = 0,

(1)

1 x1 y 1 1 (1 )2 (
x x)2 (
y y)2 1 = 0,

(2)

Now (1) implies

2 (
x x)2 1 (
y y)2

=
1
1 x1 1 y 1

and (2) implies

2 (
x x)2 (
y y)2 1
=

1
1 x 1 y 1 1

Equating these two gives

2 (
x x)2 1 (
y y)2
2 (
x x)2 (
y y)2 1
=
,
1 x1 1 y 1
1 x1 y 1 1
or
1=

1 2 x
x y
2 (
x x)2 (
y y)2 1 1 x1 1 y 1
.
=
1 x1 y 1 1 2 (
x x)2 1 (
y y)2
2 1 x y y

Thus

2 1 x
y
=
.
y y
1 2 x
x

Let
=

2 1
.
1 2

Then solving (3) for y gives

x
y,
( 1)x + x

which is an equation for y1 as a function x1 , whose graph runs from (0, 0) to (

x, y).
y=

(3)

KC Border

1.1

Pareto Efficiency Examples

The Lagrangean approach

Form the Lagrangean

(

u1 (x1 , y1 ) + u(x2 , y2 ) 2 + x (
x x1 x2 ) + y (
y y1 y2 )
The first order conditions for the Cobb-Douglas case are:
1 x1 1 1 y11 x = 0

(4)

2 x2 2 1 y22
1 x1 1 y11 1
2 x2 2 y22 1

x = 0

(5)

y = 0

(6)

y = 0

(7)

Now take ratios of equations (4) and (6) to get

1 x1 1 1 y11
1 y1
x
=
=

1
1
y
1 x1
1 x1 y1
and ratios of equations (5) and (7) to get
x
2 y2
2 x2 2 1 y22
=
=

2
2
y
2 x2
2 x2 y2
so

1 y1
2 y2
=
.
1 x1
2 x2

Now use x2 = x
x1 and y2 = y y1 , to rewrite this as (3), and proceed as before.

v. 2012.08.28::12.41