Economics Problem Set 4.pdf

# Economics Problem Set 4.pdf - Problem Set#5 < Chapter 10#1...

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Problem Set #5 < Chapter 10 #1, 2, 3, 4 > 1. Consider two ways to protect your car from theft. The Club (a steering wheel lock) makes it difficult for a car thief to take your car. Lojack (a tracking system) has stolen it. Which of these methods conveys a negative externality on other car owners? Which conveys a positive externality? Do you think there are any policy implications of your analysis? The steering wheel is visible and provides a disincentive to rob your car. It encourages the thief to rob other cars, causing a negative externality as all car owners will have to buy a club. The Lojack discourages a thief from stealing any car, as it might have a Lojack system, getting them caught. So just the possibility of having one provides a positive externality for all other car owners. 2. Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities? Fire distinguisher yields benefits on third parties. To a large extend, the benefit of fire distinguisher is private: an individual can put off the fire and save his or her properties. Beyond this benefit, however, fire distinguisher also yields positive externalities. One externality is that by putting off a fire one can prevent the fire from affecting his or her neighbors, which means overall safety for the building as a whole. b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve. The graph below describes the fire distinguisher and its positive externality. In the presence of positive externality, the social value of the goods exceeds the private value. The optimal quality, Qoptimum, is therefore larger than the equilibrium quantity, Qmarket.

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c. Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ. The market equilibrium output and socially optimal output are denoted by Market and Qoptimum. In the marginal equilibrium, the marginal consumer values the fire distinguisher more than the social benefit of producing it. This is, at Qmarket, the demand curve is below the social-value curve. Thus, Qmarekt and Qoptimum differs and increasing fire distinguisher level raises total economic well-being. d. If the external benefit is \$10 per extinguisher, describe a government policy that would yield the efficient outcome. Government can correct the market failure by inducing market participants to internalize the externality. To move the market equilibrium close to the social optimum, the positive externality requires subsidy. If government paid firms that produce fire distinguishers a \$10 subsidy for each fire distinguisher produced, the supply will shift down by the size of the subsidy, and this shift would increase the equilibrium quantity of fire distinguishers.
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• Fall '15
• Market failure, Externality, LoJack, Fredo, Orson, Education- Public Good

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