The Cake-eating problem: Non-linear sharing rules

No 26/2012, Working Papers from University of Verona, Department of Economics

Abstract: Consider the most simple problem in microeconomics, a maximization problem with an additive separable utility function over bundles of two goods which provide equal sat- isfaction to an agent. Although simple, this framework allows for a very wide range of applications, from the Arrow-Debreu contingent claims case to the risk-sharing problem, including standard portfolio choice, intertemporal individual consumption, demand for in- surance and tax evasion. We show that any Engel curve can be generated through such a simple program and the necessary and suffi cient restrictions on the demand system to be the outcome of such a maximisation process. Moreover, we identify three classes of utility function that generate non-linear sharing rules. The gap between the two expen- diture shares increases in absolute, average or marginal terms with the total amount of wealth, depending on whether DARA, DRRA and convex risk tolerance are considered. The extension of the different results to the case of more than two goods is provided.

Keywords: Cake-eating problem; sharing rules; concavity; convex risk tolerance (search for similar items in EconPapers)
JEL-codes: D11 D81 D90 G12 (search for similar items in EconPapers)
Pages: 31
Date: 2012-09
New Economics Papers: this item is included in nep-iue, nep-mic and nep-pbe
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