Fairyland has two citizens, Cosmo and Pixie. Each has the same utility function, U=ln(C) . Both earn $1000 in their full-time jobs, but both face
Fairyland has two citizens, Cosmo and Pixie. Each has the same utility function, U=ln(C) . Both earn $1000 in their full-time jobs, but both face
some risk of being laid off due to a potential shortage of fairy dust, in which case they will only earn $250 in an alternate part-time job. There is a 10% chance that Cosmo will be laid off and a 30% chance Pixie will be laid off. The Governor of Fairyland, Jorgen von Strangle, is considering providing unemployment insurance. In particular, Jorgen is considering two plans: the first would pay any worker who loses his job $100; the second would pay any worker who loses his job $600. Both plans would be financed by collecting a tax from any worker who keeps his job.
a. Under each plan, how high does Jorgen have to set the tax so that the government does not lose money on the plan?
b. For the tax from part a, compute the well-being of Cosmo and Pixie under each plan.
c. For three possible policies (the two plans and the status quo of no plan), how do Cosmo and Pixie rank the policies, respectively, in terms of their own well-being.
