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PS1-Fall2009 - Econ 131 Problem Set#1 Fall 2009 1 You set...

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Unformatted text preview: Econ 131 Problem Set #1 Fall 2009 1. You set up wireless connection in your home. Assume that you cannot protect it with a password, and hence any individual in the range of the connection can use it. What type of market failure best describes the situation at hand? Provide a similar example in the environment. 2. We have discussed four types of market failure in class, ecosystem externalities, global public goods, tragedy of the commons, and incomplete information. For each type, explain carefully which necessary conditions for efficiency of a market mechanism are violated. 3. Give an environmental example for each of the following: moral hazard and adverse selection. Explain carefully why they are examples of hidden information. 4. Letting consumers and producers be price-takers as well as utility/profit maximizers, carefully explain why the supply curve is equal to the marginal cost curve, and why the demand curve is equal to the marginal benefit curve. 5. The production of bubble gum exhibits the following social marginal cost (supply) curve, P=2+0.5Q, and the social marginal benefit (demand) curve is given by P=6-2Q. a. Assuming that all necessary conditions for efficiency is present in this market, find the price and quantity that maximize total net benefits, P* and Q*. Explain intuitively why P* and Q* maximize total net benefits. (Hint: what would be the marginal benefit and marginal cost if one extra unit beyond Q* was consumed or if one less unit of Q* was consumed .) b. Illustrate on a graph and compute total willingness to pay, total variable costs, producer surplus and consumer surplus. c. Now assume that there is a negative externality that leads the social marginal cost curve to be P=3+0.5Q (the demand is unaffected). Before doing any mathematics, intuitively speaking, is the new efficient quantity, Q**, greater or smaller than Q* in part a? d. Now compute P** and Q** that maximize total net benefits under the externality. ******************************** The next four problems are based on the following Regulation vs. Market example: A city provides water to two households. Household one's demand for water is given by , where q is in gallons and p is in $/gallon. Household two's demand for water is given by 6. If the city charges $10/gallon, how much water will each household consume? How much surplus value does each household receive? . The city is going through a drought and must cut total water consumption by 60 gallons. Fearful of upsetting the households, the mayor argues against raising the price. Instead, the mayor wants to require each household to cut consumption by 30 gallons. 7. How much surplus value would each household receive? Would this policy result in an efficient allocation of water between the two households? The mayor's advisor suggests increasing the price of water in order to achieve the required 60 gallon reduction in total water consumption. 8. What would the new price need to be in order to achieve a 60 gallon reduction in consumption? How much surplus would each household receive? Would this policy result in an efficient allocation of water between the two households? 9. Would either household be better off under the advisor's policy? Could the city find a way to compensate the households in order to gain support for the policy? ...
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