PS4_answers - to minimize the sum of total costs of removal...

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Legal Studies 145 - Law and Economics I Answers to P ROBLEM S ET #4 1. The marginal benefit and marginal cost curves are shown in the figure below. The efficient solution minimizes the sum of the total harm and total cost of removal, which can be determined as the percentage of removal at which the marginal benefit (MB) equals the marginal cost (MC). The intersection at point D tells us the level of removal. Solving algebraically, MC = 10P = MB = 6-2P, yields P = .5 2. Firms now must add to the cost of removal (5P 2 ) the payment of damages (4(1-P)+ (1-P) 2 , and minimize the sum of both. The firm can do this by choosing a P such that its marginal cost of removal is equal to its marginal reduction in damage payments. Since the latter is given by MB, the firm can internalize the cost of emission by choosing the P where MC = MB. This is socially efficient. Another way to work this out is to use the calculus
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Unformatted text preview: to minimize the sum of total costs of removal and total harm, i.e., Minimize 5P 2 +4(1-P)+(1-P) 2 The optimal value of P solves the equation 4P = 2, or P = .5. For those not using the calculus, you can calculate total costs (TC + TD) for possible values of P and choose the cost-minimizing value: P TC TD TC + TD 0.0 0.00 5.00 5.00 .1 .05 4.81 4.86 .2 .20 3.84 4.04 .3 .45 3.29 3.74 .4 .80 2.76 3.56 .5 1.25 2.25 3.50 .6 1.80 1.76 3.56 .7 2.45 1.29 3.74 Once again the solution is P = .5 3. In this situation the individuals require the factory to remove 50 percent of emission. The factory receives as compensation all of its removal costs and therefore is made no worse off than if it had done nothing. The individuals pay the factory the total cost of removal, 1.25, but are happy to do so since they reduce harm by substantially more. Note that there is no possibility of strategic behavior here....
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This homework help was uploaded on 04/16/2008 for the course LEGALST 145 taught by Professor Rubenfield during the Spring '08 term at Berkeley.

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PS4_answers - to minimize the sum of total costs of removal...

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