\documentclass{article}

\begin{document}
{\bf Question 1}
Please note, I accidentally mixed up the signs. h is "high productivity" and l i
s "low productivity". This implies $\theta_h < \theta_l$. Note since all consume
rs are the same can use consumer i as a representative agent.
$
\\ \\
Max U = \lambda[Yi - t_hi - Ax_h ] + (1-\lambda)[Yi - t_li - Ax_l ]
\\ \\
$
The constraints for this problem are as follows:
$\\ \\
\pi_l = 0 $ (rationality constraint - low productivity needs at least 0 profit t
o produce)$
\\ \\
\pi_h = \pi_h(x_l,T_l) $ (incentive compatibilty constraint - high productivity
firm needs at least the profit they would earn building the smaller bride to pro
duce the bigger bridge)$
\\ \\
\pi_l = t_{li} *m - k - \theta_l x_l^2
\\ \\
t_{li} *m - k - \theta_l x_l^2 = 0
\\ \\
t_{li} = \frac{k + \theta_l x_l^2}{m}
\\ \\
\pi_h = t_{hi} *m - k - \theta_h x_h^2
\\ \\
t_{li} *m - \theta_h x_l^2 = t_hi *m - \theta_h x_h^2
\\ \\
t_{hi} = \frac{\theta_h x_h^2 - \theta_h x_l^2}{m} + t_{li}
\\ \\
t_{hi} = \frac{\theta_h x_h^2 - \theta_h x_l^2}{m} + \frac{k + \theta_l x_l^2}{m
}
\\ \\
$
Now sub in the tax function into the utility function
$
\\ \\
Max U = \lambda[Yi - \frac{\theta_h x_h^2 - \theta_h x_l^2 + \theta_l x_l^2}{m}
+ t_{li} + Ax_h ] + (1-\lambda)[Yi - \frac{k + \theta_l x_l^2}{m} - Ax_l ]
\\ \\
\frac{dU}{dx_h} = -\lambda 2*\frac{\theta_h x_h}{m} - \lambda A = 0
\\ \\
\frac{dU}{dx_l} = -2\lambda \frac{\theta_h x_l + \theta_l x_l}{m} (1-\lambda)
2*\frac{(\theta_l)x_l}{m} - (1-\lambda) A = 0
\\ \\
x_h = \frac{mA}{2\theta_h}
\\ \\
-2\lambda \frac{\theta_h x_l}{m} + 2*\frac{(\theta_l)x_l}{m} = (1-\lambda) A
\\ \\
-\lambda \theta_h x_l + (\theta_l)x_l = \frac{(1-\lambda)mA}{2}
\\ \\
x_l = \frac{(1-\lambda)mA}{2(\theta_l -\lambda \theta_h)}
\\ \\
T_{l} = K + \theta_l(\frac{(1-\lambda)mA}{2(\theta_l -\lambda \theta_h)})^2
\\ \\
T_{h} = \theta_h (\frac{mA}{2\theta_h})^2 + (\theta_l - \theta_h) (\frac{(1-\lam
bda)mA}{2(\theta_l -\lambda \theta_h)})^2 + K

\\ \\
$
To ensure the bridge is constructed The expected utility of construction must ou
tweigh the disutility caused i.e $E[Ax] >= E[t]$ for any individual
$
\\ \\
\lambda[Ax_h - (m\theta_h (\frac{A}{2\theta_h})^2 + (\theta_l - \theta_h) (\frac
{(1-\lambda)mA}{2(\theta_l -\lambda \theta_h)})^2 + \frac{K}{m})] + (1-\lambda)[
A\frac{(1-\lambda)mA}{2(\theta_l -\lambda \theta_h)} - (\frac{K}{m} + m\theta_l(
\frac{(1-\lambda)A}{2(\theta_l -\lambda \theta_h)})^2)] >= 0
\\ \\
\lambda[A\frac{mA}{2\theta_h} - (m\theta_h (\frac{A}{2\theta_h})^2 + m(\theta_l
- \theta_h) (\frac{(1-\lambda)A}{2(\theta_l -\lambda \theta_h)})^2] + (1-\lambda
)[Ax_l - m\theta_l(\frac{(1-\lambda)A}{2(\theta_l -\lambda \theta_h)})^2)] >= \f
rac{k}{m}
\\ \\
$
(Please empathize that re-arranging these equations is very difficult in latex s
o i cannot simplify much further. In essence, this equality must hold for consum
ers to want the bridge to be built as opposed to just consuming the private good
.)
$
\\
\\
$
The high productivity firm does the first best as their optimal x does not depen
d on how much $x_l$ is offered. We can show that the optimal x is the same when
there is no uncertainty.
$
\\ \\
Max U = [Yi - \frac{\theta_h x_h^2 - \theta_h x_l^2 + \theta_l x_l^2}{m} + t_li
+ Ax_h ]
\\ \\
\frac{dU}{dx_h} = -2*\frac{\theta_h x_h}{m} - A = 0
\\ \\
x_h = \frac{mA}{2\theta_h}
\\ \\
$
The optimal x is the same in both cases so they produce the first-best even with
uncertainty present. For the second part to this question, we must show aggrega
te income is larger then the biggest tax. Logically, we can assume $T_h > T_l$ a
s they would otherwise build the cheaper smaller bridge. However, we can trivial
ly show it:
$
\\ \\
\theta_h (\frac{mA}{2\theta_h})^2 + (\theta_l - \theta_h) (\frac{(1-\lambda)mA}{
2(\theta_l -\lambda \theta_h)})^2 + K > K + \theta_l(\frac{(1-\lambda)mA}{2(\the
ta_l -\lambda \theta_h)})^2
\\ \\
\theta_h (\frac{mA}{2\theta_h})^2 + (\theta_l - \theta_h) (\frac{(1-\lambda)mA}{
2(\theta_l -\lambda \theta_h)})^2 > \theta_l(\frac{(1-\lambda)mA}{2(\theta_l -\l
ambda \theta_h)})^2
\\ \\
\frac{1}{\theta_h} - \frac{(1-\lambda)}{(\theta_l -\lambda \theta_h)} > 0
\\ \\
(\theta_l -\lambda \theta_h) > (1-\lambda)\theta_h
\\ \\
\theta_l > \theta_h
$
Which by definition is true. Therefore we need to show $m*y_i > T_h$

$
\\ \\
Y_i >= T_h
\\ \\
Y_i >= \theta_h \frac{mA}{2\theta_h}^2 + (\theta_l - \theta_h) \frac{(1-\lambda)
mA}{2(\theta_l -\lambda \theta_h)}^2 + K
\\ \\
$
{\bf Question 2}
Please note, I accidentally mixed up the signs, again. l denotes the more risky
consumer and h the healthy consumer has lower probability of getting sick. The f
irst constraint is the $ \lambda_1 $ is the rationality constraint and the secon
d, $ \lambda_2$, the incentive compatibility constraint
$
\\ \\
L = \frac{1600 - W_g^h - W_b^l }{3} + \frac{400 - W_g^l - W_b^h }{6} + \lambda_1
[ \frac{100}{3} - 2*\sqrt{W_g^h} - \sqrt{W_b^h} ] + \lambda_2 [ \sqrt{W_g^h} +
2* \sqrt{W_b^h} - \sqrt{W_g^l} - 2*\sqrt{W_b^l} ]
\\ \\
$
F.O.C
$
\\ \\
\frac{dL}{dW_g^h} = \frac{-1}{3} - \frac{\lambda_1}{\sqrt{W_g^h}} + \frac{\lambd
a_2}{2\sqrt{W_g^h}} = 0
\\ \\
\frac{dL}{dW_b^h} = \frac{-1}{6} - \frac{\lambda_1}{2\sqrt{W_b^h}} + \frac{\lamb
da_2}{\sqrt{W_b^h}} = 0
\\ \\
\frac{dL}{dW_g^l} = \frac{-1}{6} - \frac{\lambda_2}{2\sqrt{W_g^l}} = 0
\\ \\
\frac{dL}{dW_b^l} = \frac{-1}{3} - \frac{\lambda_2}{\sqrt{W_b^l}} = 0
\\ \\
100 = 2*\sqrt{W_g^h} + \sqrt{W_b^h}
\\ \\
\sqrt{W_g^h} + 2* \sqrt{W_b^h} = \sqrt{W_g^l} + 2*\sqrt{W_b^l}
\\ \\
$
re-arranging
$
\\ \\
-\sqrt{W_g^l} = 3\lambda_2
\\ \\
-\sqrt{W_b^l} = 3\lambda_2
\\ \\
\frac{-1}{3} = \frac{2\lambda_1 - \lambda_2}{2\sqrt{W_g^h}}
\\ \\
\frac{-1}{6} = \frac{\lambda_1 - 2\lambda_2}{2\sqrt{W_b^h}}
\\ \\
-2\sqrt{W_g^h} = 6\lambda_1 - 3\lambda_2
\\ \\
-2\sqrt{W_b^h} = 6\lambda_1 - 12\lambda_2
\\ \\
-2\sqrt{W_g^h} = 6\lambda_1 + \sqrt{W_g^l}
\\ \\
-2\sqrt{W_b^h} = 6\lambda_1 + 4\sqrt{W_b^l}
\\ \\
2\sqrt{W_g^h} + \sqrt{W_g^l} = 2\sqrt{W_b^h} + 4\sqrt{W_b^l}
\\ \\

2\sqrt{W_g^h} = 2\sqrt{W_b^h} + 3\sqrt{W_b^l}

\\ \\
\sqrt{W_g^h} + 2* \sqrt{W_b^h} = 2\sqrt{W_g^h} - 2\sqrt{W_b^h}
\\ \\
\sqrt{W_g^h} = 4\sqrt{W_b^h}
\\ \\
100 = 9*\sqrt{W_b^h}
\\ \\
\frac{100}{9} = \sqrt{W_b^h}
\\ \\
(\frac{100}{9})^2 = W_b^h
\\ \\
W_b^h = 123.45
\\ \\
W_g^h = 1975.2
\\ \\
\pi^h = \frac{2}{3}(1975.2-1600) + \frac{2}{3}(400-123.45) <0
\\ \\
$
Since the expected profit from selling to consumer h is negative, they will not
offer this consumer a contract. For consumer l they will sell a contract which s
atisfies their participation constraint s.t (will let it be binding)
$
\\ \\
\frac{1}{3}\sqrt{W_g^l} + \frac{2}{3}\sqrt{W_b^l} = \frac{1}{3}\sqrt{1600} + \fr
ac{2}{3}\sqrt{400}
\\ \\
\sqrt{W_g^l} + 2\sqrt{W_b^l} = 80
\\ \\
W_g^l = (80 - 2\sqrt{W_b^l})^2
\\ \\
\pi = \frac{1600 - W_g^l}{3} + \frac{400 - 2W_b^l}{3}
\\ \\
\pi = \frac{1600 - (80 - 2\sqrt{W_b^l})^2}{3} + \frac{400 - 4W_b^l}{3}
\\ \\
\frac{d\pi}{dW_b^l} = \frac{160-2\sqrt{W_b^l})}{3\sqrt{W_b^l}} - \frac{4}{3} = 0
\\ \\
480 -6\sqrt{W_b^l}) = 12\sqrt{W_b^l}
\\ \\
\sqrt{W_b^l} = \frac{480}{18}
\\ \\
W_b^l = 711.11
W_g^l = (80 - 2
\\ \\
\sqrt{711.11})^2 = 711.11
$
The consumer with high risk fully insures, which can be seen in our lagrangean w
here the wealth in both states both equal the multiplier times 3.

\end{document}