Econ 001 Levinson -- Fall 2009

of 8 Print this page. Econ 001 Levinson -- Fall 2009 Homework 9 Scenario This problem asks you to examine the marginal costs and marginal benefits in the market for gasoline. The marginal benefit to society from the consumption of a gallon of gasoline is equal to the sum of the marginal private benefit enjoyed by the buyer of the gasoline and any marginal external benefits received by other members of society. The marginal cost to society of consuming a gallon of gasoline is equal to the sum of the marginal private cost to the buyer of the gasoline and any marginal external costs incurred by other members of society. Since the benefits from a gallon of gasoline come only from the mobility that it gives to a driver, there are no external benefits. Therefore the marginal private benefit equals the marginal social benefit. The cost of gasoline consumption comes in two parts. The driver pays the market price for the gasoline. This is the marginal private cost of the gasoline. In addition, other people who live in the area pay a cost because they suffer from the pollution created by burning the gas. This is the marginal external cost of gasoline consumption. Since external costs exist in the consumption of gasoline, the marginal social cost of a gallon of gas exceeds the marginal private cost. As usual, the marginal benefits of gasoline consumption fall with total consumption. The benefit from the first gallon of gasoline consumed is higher than the benefit offered by the millionth gallon consumed. In this graph, the two components of marginal cost (MC) are constant. The marginal private cost is a horizontal line because people in this country pay a constant cost per gallon for gasoline. The marginal external cost of the pollution associated with the burning of gasoline is also constant. Question 1.1 1.1. According to the graph, the marginal private cost of a gallon of gasoline is and the marginal social cost is. A. $3, $2

of 8 B. $2, $3 C. $2, $1 D. $1, $2 Question 1.2 1.2. If the government does not intervene in the market for gasoline, drivers will buy million gallons of gasoline. Question 1.3 1.3. Which of these statements correctly describes the market for gasoline? A. The market will lead to the consumption of too much gasoline. B. The market outcome is efficient. C. Society would prefer that more gasoline be produced. D. At the equilibrium quantity, the marginal private cost of gasoline exceeds the private benefit. Question 1.4 1.4. Suppose that government regulators try to deal with the negative pollution externalities by imposing a binding limit on the quantity of gasoline that gas stations can sell. Together, the stations can sell a maximum of 30 million gallons, the efficient level of consumption of gasoline. Which statement best describes the effects that these measures will have on economic welfare? A. This intervention does not correct the pollution externality because people who buy gasoline still face a private cost that is lower than the social cost. B. This intervention will restore efficiency in the market for gasoline because it limits the quantity to the efficient level. Question 1.5 1.5. Suppose that the government decides not to use quantity limits and price controls. Instead it imposes a tax on gasoline. According to the graph, the government should impose a tax of: A. $1 B. $2 C. $3 D. $4 Scenario In these problems, you are asked to work with a graph that shows marginal benefits and costs in a market. The graph is not correct in its current form. Your task is to read the description of the market and then to adjust the graph so that it correctly displays a difference between marginal private and social costs or marginal private and social benefits in that

of 8 market. You can adjust the graph by dragging the benefit or cost curve to a new position. If you do this, you will see two curves with their own labels, one that shows the marginal social benefit or cost and another curve that shows the marginal private cost or benefit. Tool tip: To shift a curve, place your mouse over any part of a curve, and then drag the curve up or down. Curves will snap into position, so if you try to move the curve and it snaps back to its original position, just try again and drag it a little further. When you are satisfied with your answer, click the Submit Answer button.

of 8 Question 2.1 2.1. The market for flu vaccinations In this market, people pay the cost of getting a flu shot. Flu shots protect an individual from getting sick, which is especially valuable for people with poor health. Flu shots also limit the spread of the disease to others. When more people have flu shots, even people who don't get flu shots are less likely to get sick. The cost of a flu shot is made up of the cost required to manufacture the vaccine and the time required for a health care worker to administer the shot. The graph currently shows the market equilibrium for flu shots. Shift one or both of the curves to illustrate the efficient level of flu shots.

of 8 Question 2.2 2.2. The market for electricity Bill has installed security lighting on his property. These lights give him a private benefit. But the lighting also confers some positive external benefits for his neighbors because the lights keep burglars away from their property as well. Electricity also has negative external effects. Generating electricity usually cause pollution. Adjust the benefit and cost curves (or both) to illustrate the private and social benefits and costs in the market for electricity. Scenario (Coase theorem, applied.) Consider two roommates Monica and Rachel who are sharing an apartment with a common kitchen. Suppose Monica owns the apartment. Monica is obsessively tidy and organized, and becomes very annoyed when Rachel leaves dirty dishes in the sink. It is worth $3 to Rachel to be able to leave her dishes. A clean sink is worth $2 to Monica. Question 3.1 3.1. What is the economically efficient arrangement of clean or dirty dishes? A. Dirty B. Clean Question 3.2 3.2. Will that efficient arrangement be negotiated? Who will pay whom? A. No, Coase says it will not be negotiated. B. Yes, Monica will pay Rachel between $2 and $3. C. Yes, Rachel will pay Monica between $2 and $3..

of 8 D. Yes, no money will change hands. Question 3.3 3.3. Now suppose that it is Rachel that owns the apartment. What is the efficient arrangement? Is it the same as above? Will this arrangement be negotiated? Who will pay whom? A. Dirty dishes, Rachel will pay Monica. B. Dirty dishes, Monica will pay Rachel. C. Clean dishes, Rachel will pay Monica. D. Clean dishes, Monica will pay Rachel. E. Dirty dishes, no money will change hands. F. Clean dishes, no money will change hands. Scenario: Public and private goods Public and private goods Scooter and Karl are the only residents of a small country called... (well, make up your own name). One of the goods they enjoy is called widgets. The price of widgets is $2 per widget. (This price is set outside of the country, so take it as exogenously given. I.e. there is no supply curve, or the supply curve is completely elastic at P=2). Scooter's demand for Widgets is QScooter = 12-1.5P Karl's demand for widgets is QKarl = 12-3P Question 4.1 4.1. Suppose widgets are a private good (rival and excludable). What is the market equilibrium quantity of widgets? (I.e. at P=2 how much do Scooter and Karl collectively demand?) Question 4.2 4.2. Now suppose widgets are a public good (nonrival and nonexcludable). What is the market equilibrium quantity of widgets? (I.e. at P=2 how much do Scooter and Karl collectively demand?) Question 4.3 4.3. If widgets are public, as in (b), what is the efficient quantity of widgets for Scooter and Karl to collectively demand? Scenario

of 8 Suppose the market for burritos in Collegetown is dominated by one large monopolist. Market demand for burritos and marginal revenue are given by the equations Qd = 120 - P MR = 120-2Q where P is the price of burritos and Q is the quantity of burritos. Suppose furthermore that the total cost and marginal cost of producing burritos are given by the equations TC = 10 + 60Q + Q^2 (Q^2 means Q squared) MC = 60 + 2Q Question 5.1 5.1. If the monopolist can only charge one price for all of the burritos it sells (it is a single-price monopolist), what is its profit-maximizing price? (Be careful, I am asking for price, not cost.) Question 5.2 5.2. Now suppose that the city of Collegetown breaks up the burrito monopoly into many smaller, competitive firms. For simplicity, assume that the monopolist's original MC curve becomes the market supply curve; that is, QS = 0.5P - 30 What will be the market equilibrium price? Question 5.3 5.3. Unfortunately, burritos create a certain negative externality. (Need I be graphic?) The marginal external cost is calculated to be 15 per burrito. What is the socially efficient quantity of burritos? Assume that the market is competitive as in 2.2. Question 5.4 5.4. What is the tax per burrito on the competitive burrito sellers that would achieve the economically efficient outcome? (Assume that the market is competitive as in 2.2.) Question 5.5 5.5. Now suppose that burritos are monopolized as in the first part of this question, AND that they generate an externality, as in the last part. What is the tax per burrito that would achieve the economically efficient outcome?

of 8 Question 6 6. This morning I looked in the newspaper and saw that the price of gold is $832 per ounce. I also found the interest rate on 1-year U.S. Treasury notes, which is 3.4 percent (annual). Suppose that gold supply is perfectly competitive, and costless to extract. What is the market predicting for the price of gold one year from today? $ Please enter 2 digits after the decimal point. Copyright 2001-2009, Aplia Inc. All rights reserved.