The Cake-Eating Problem: Non-Linear Sharing Rules
31 Pages Posted: 26 Sep 2012
Date Written: September 25, 2012
Consider the most simple problem in microeconomics, a maximization problem with an additive separable utility function over bundles of two goods which provide equal satisfaction 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 insurance and tax evasion. We show that any Engel curve can be generated through such a simple program and the necessary and sufficient 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 expenditure 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: Recoverability, cake-eating problem, sharing rules, concavity, convex risk tolerance
JEL Classification: D11, D81, D90, G12
Suggested Citation: Suggested Citation