AEM_250_Review_3 - 8. (8 points) Use the graph below, which...

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8. (8 points) Use the graph below, which depicts market demand and market supply for a product along with the marginal external social costs of the pollution caused by producing the good, to answer the following questions. 0 1 2 3 ` Adam Smith, and later Milton and Rose Friedman, argued that rational individuals operating in their own self-interest will arrive at the socially optimal level of output in a market economy. a. Why does, or does not, this “invisible hand” theorem apply to the situation above? The market ignores externalities and hence arrives at the market equilibrium (iii,2) rather than the social equilibrium (iv,1). Hence, individuals acting in their own self interests and working through markets do not maximize the net economic surplus. I rewarded people who mentioned the self-interest component, as I think that that is the key to the invisible hand. b. What is the difference, if any, between the net economic surplus associated with the market equilibrium and net economic surplus
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This note was uploaded on 11/06/2008 for the course AEM 2500 taught by Professor Poe,g. during the Fall '07 term at Cornell University (Engineering School).

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AEM_250_Review_3 - 8. (8 points) Use the graph below, which...

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