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ProblemSet_1_2009_solutions

# ProblemSet_1_2009_solutions - EEP 101/Econ 125 Spring 2009...

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EEP 101/Econ 125 Spring 2009 GSIs: Brian, Jenny Problem Set #1: due on Tuesday, February 17 at lecture. Late assignments will not be accepted. &umerical Questions (1) ( 40 Points ) Suppose that an industry has an inverse demand curve given by P = 70 – 3Q, where P is the price in dollars, and Q is the quantity. The marginal private cost (MPC) of production is MPC = 10 + Q, and the marginal external cost of production (MEC) is given by MEC = 2Q. For all parts of this question, solve the problems algebraically (i.e. show your work) and illustrate your solution on an appropriate graph, making sure you clearly label your numerical solutions and graphs. a) Determine the socially optimal level of output (Q*). Calculate the total external cost (TEC*), consumer surplus (CS*), producer surplus (PS*), and total social welfare (SW*) at this level of output. b) Calculate the quantity produced if the market is in perfect competition and only private costs are accounted for (the externality associated with production is NOT taken into account). What is the quantity produced (Q c )? Calculate the total external cost (TEC c ), consumer surplus (CS c ), producer surplus (PS c ), total social welfare (SW c ) and dead-weight loss (DWL c ) at this level of output. c) Now assume that there is only a single producer in the industry (monopoly). What is the quantity produced (Q m )? Calculate the total external cost (TEC m ), consumer surplus (CS m ), producer surplus (PS m ), total social welfare (SW m ) and dead-weight loss (DWL m ) under a monopoly. d) Now suppose that the government wants to fix the externality problem using a price mechanism (tax or subsidy). Calculate the optimal tax or subsidy under a competitive market (part b) and under a monopoly (part c). Graphically, show how this tax or subsidy (choose one) is chosen under both cases. e) Assume that the market is perfectly competitive, and the government imposes the appropriate tax or subsidy (calculated in part d). Be sure that you clearly indicate which one you are using! Compared to (part b), how do the government’s finances change? What is the change in consumer surplus, producer surplus, total external costs, and social welfare? What is the level of dead-weight loss? (2)

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ProblemSet_1_2009_solutions - EEP 101/Econ 125 Spring 2009...

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