In an Edgeworth box, apples are measured along the horizontal axes, and oranges are measured along the vertical axes. Player 1 is in the lower left-hand corner; player 2 is in the upper right-hand corner. Player 1 likes apples but gets no utility from the consumption of oranges. Player 2 likes oranges but gets no utility from the consumption of apples. In the initial endowment, Player 1 has 5 apples and 4 oranges. Player 2 also has 5 apples and 4 oranges. What is the contract curve?
A)All points along the horizontal axis.
B)All points along the vertical axis.
C)All points to the right and below the initial endowment point.
D)The point where Player 1 has 10 apples and 0 oranges, and Player 2 has 8 oranges and 0 apples.

Question

Quizplus · Accepted Answer

Since Player 1 likes apples and Player 2 likes oranges, they can both benefit by trading. The contract curve is the set of Pareto efficient allocations. In this case, since both players have the same initial endowment of goods, the contract curve will be a straight line passing through the initial endowment point and the 45-degree line. This straight line will connect the point where Player 1 has 10 apples and 0 oranges (i.e. 5 apples from Player 1’s initial endowment plus 5 apples from Player 2’s initial endowment) and the point where Player 2 has 8 oranges and 0 apples (i.e. 4 oranges from Player 1’s initial endowment plus 4 oranges from Player 2’s initial endowment). Therefore, the best choice is D. The contract curve represents the set of Pareto-efficient allocations that can be achieved through trade between the two players. Since Player 1 only likes apples and Player 2 only likes oranges, they will want to trade their excess fruit with each other to achieve a mutually beneficial outcome. The initial endowment of 5 apples and 4 oranges for each player is not Pareto-efficient, as Player 1 would be willing to give up some oranges for more apples, and Player 2 would be willing to give up some apples for more oranges. The contract curve will be the set of points where such trades can take place.

One possible Pareto-efficient allocation that can be achieved through trade is the following: Player 1 gives all 4 of their oranges to Player 2 in exchange for 5 more apples, leaving them with 10 apples and 0 oranges. Player 2 gives all 4 of their apples to Player 1 in exchange for 4 more oranges, leaving them with 8 oranges and 0 apples. This allocation is Pareto-efficient because neither player can be made better off without making the other player worse off.

Therefore, the contract curve includes the point where Player 1 has 10 apples and 0 oranges, and Player 2 has 8 oranges and 0 apples. The other choices are not on the contract curve.

In an Edgeworth Box, Apples Are Measured Along the Horizontal