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Unformatted text preview: Ch. 15 Externalities Practice Problem Answers by Charles Lin. Send any corrections to lin.charles@gmail.com November 18, 2007 #1. a. If the market is competitive and unregulated, the market will produce where Marginal Personal Bene t (MB) = Marginal Personal Cost (S, MC). Therefore, the equilibrium quantitiy will 150 units per week, and the equilibrium price will be $10 per unit. b. The e cient quantity is found by setting marginal social bene t (MSB) equal to Marginal Cost (MC). Therefore, the e cient quantity 250 units per week, and the e cient price is $15 per unit. In this case, the e cient quantity is higher than the unregulated equilibrium quantity. The deadweight loss is equal to the area of the triangle to the left of the socially e cient equilibrium, but to the right of the Q = 150 line. Therefore, the deadweight loss is equal to 1 2 (20 10)(250 150) = 500 . The deadweight loss is therefore $500 per week. c. To achieve e ciency, the government should set the subsidy equal to the positive externality. This is the vertical distance between the MSB and the MB curve. This distance is equal to $10 per unit. Therefore the subsidy should equal $10 per unit. d. If the e cient subsidy is implemented, the new price and output will equal the social optimum. As was calculated in part b, The e cient price is $15 per unit, and the e cient quantity is 250 units per week. The price that producers receive is $15 per unit. The price that consumers pay is $5, and the government pays a subsidy of $10. #2. a. According to the Coase Theorem, if we assume there are no holdout problems, The smoker will pay each nonsmoker at least 50 cents to agree to let the smoker smoke. However, the smoker's total payments cannot exceed $5, because this is his maximum willingness to pay. b. In this scenario, no payments will be made. The nonsmokers will attempt to bribe the smoker to stop. Each of the nine nonsmokers will o er a maximum of 50 cents, for a total of $4.50. However, the smoker values the ne, luxurious smoke of a cigar at $5, and so will refuse to stop smoking. In both scenarios (a and b), the outcome is the same  the smoker will end up smoking, because...
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 Spring '08
 Kim
 Microeconomics, Externalities

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