Pareto Optimality

Copy each diagram without the purple arrow and follow the exercise instructions.

Exercise 1: Draw the indifference curves for this new point. Find another point that is pareto superior to that point.

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Exercise 2: Draw the indifference curve for red at the new point. (a) try a movement along the blue indifference curve; (b) try a movement along the red indifference curve. Which one (a) or (b) leads to the least loss for blue from the endowment point? 

Answer: (b) allows an upward shift in blue's indifference curve, blue recovers some utility as it shifts to become tangent with red.

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Exercise 3: What is the initial allocation for blue at the endowment point? Draw both side's indifference curves and identify the lens. Try out some bargaining points and see if it lands on the contract curve (it may not because these are sketches, but the pareto optimal bargaining points should be close to the core in your drawings).