E130PS3 - Professor Valerie Ramey Econ 130 Fall 2007...

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Professor Valerie Ramey Econ 130, Fall 2007 Problem Set #3 1. Does the free market overproduce or underproduce goods with positive externalities? Explain using a graph. 2. Suppose the marginal social benefit, or inverse demand for gasoline is given by: MSB = P = 200 – Q The marginal private cost, or inverse supply curve, is: MPC = P = 20 + Q Q is gallons of gasoline and P is measured in cents per gallon. Suppose an economist adds up the marginal external costs (per gallon) imposed by driving in terms of pollution, congestion, and accidents and estimates that the marginal external cost schedule looks like: MEC = 100 cents A. With no government intervention, what will be the equilibrium price of gasoline and number of gallons sold? B. Find the MSC of gasoline schedule. C. What is the socially optimal number of gallons of gasoline sold? D. Use a graph to show the deadweight loss when there is no government intervention. Calculate the area of the deadweight loss triangle.
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