Quiz+4+Econ+101+Winter+2010_suggested solution

Quiz+4+Econ+101+Winter+2010_suggested solution - Economics...

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Unformatted text preview: Economics 101 Section 400 Winter 2010 Quiz 4 For discussion in section, March 18 and 19 Name:______________________________________ Section:________________ Consider
the
diagram
below,
depicting
demand
and
supply
for
curves
for
bacon.

Values
 on
the
horizontal
axis
are
measured
in
thousands
of
pounds
per
week,
and
values
on
the
 vertical
axis
are
measured
in
dollars
per
pound.
 
 To
supply
bacon
to
the
market,
bacon
producers
must
farm
pigs.

Unfortunately,
pig
 farming
is
a
dirty
and
smelly
business,
and
it
generates
significant
costs
for
those
who
 live
near
to
the
farms.

Suppose
the
producers
impose
$4
of
external
costs
on
those
who
 live
nearby
for
every
pound
of
bacon
produced.
 $20 Supply
 $10 Demand
 250
 500
 (a) If
all
bacon
producers
and
bacon
consumers
are
price
takers,
and
are
able
to
 transact
freely
with
each
other
in
the
bacon
market
(but
not
with
those
who
live
 near
the
farms),
what
quantity
of
bacon
will
be
sold
in
the
market?

At
this
 quantity,
what
is
the
value
of
the
marginal
pound
of
bacon
to
consumers?

What
 is
the
private
cost
to
producers
of
producing
the
marginal
pound
of
bacon?
 
 ANSWER:
 
 250,000
pounds
of
bacon
will
be
sold
in
the
market.

At
this
quantity,
the
value
of
 the
marginal
pound
of
bacon
to
consumers
is
$10.


The
private
cost
to
producers
of
 producing
the
marginal
pound
of
bacon
is
also
$10.
 
 ANSWER:
 The
external
cost
imposed
by
production
of
the
marginal
pound
of
bacon
is
$4.

Hence,
 the
social
cost
of
producing
the
marginal
pound
of
bacon
is
$10
+
$4
=
$14.

This
is
 illustrated
in
the
diagram
below:
 
 (b) If
the
quantity
of
bacon
produced
is
as
predicted
in
part
(a),
what
external
cost
is
 imposed
by
production
of
the
marginal
pound
of
bacon?

What
is
the
social
cost
 of
producing
the
marginal
pound
of
bacon?

On
the
diagram
above,
sketch
the
 marginal
social
cost
curve
showing
the
social
costs
of
producing
each
 incremental
pound
of
bacon?
 
 
 
 (c) The
quantity
of
bacon
identified
in
part
(a)
is
not
the
efficient
production
 quantity.
Is
it
possible
to
reallocate
resources
to
make
somebody
better
off
 without
hurting
anybody
else?
If
so,
how?
If
not,
why
not?
Then,
identify
on
your
 diagram
the
efficient
quantity
of
bacon
to
be
produced.

 
 ANSWER:
 
 Yes,
it
is
possible
to
reallocate
resources
to
make
somebody
better
off
without
 hurting
anybody
else.

If
we
assign
and
enforce
property
rights
over
the
right
to
 benefit
from,
or
to
impose,
an
externality,
and
if
agents
are
free
to
trade
these
 rights,
then
Coasean
(private)
bargaining
can
lead
to
the
efficient
outcome.


 
 For
example,
we
can
assign
the
right
to
pollute
to
the
bacon
producers.

The
 producers
can
agree
to
reduce
bacon
production
if
the
people
living
near
pig
farms
 agree
to
compensate
them
in
some
way.

Because
the
producers
impose
an
 
 
 externality
cost
of
$4
per
pound
of
bacon
produced,
the
people
who
live
near
pig
 farms
would
then
be
willing
to
pay
the
producers
exactly
this
amount.

In
return,
the
 bacon
producers
would
agree
to
reduce
output
to
the
efficient
level,
where
the
 social
marginal
benefit
is
just
equal
to
the
full
social
cost
of
producing
bacon.

(See
 diagram
above
for
the
efficient
quantity.)
 
 Alternatively,
we
can
assign
the
right
to
clean
environment
and
fresh
air
to
the
 people
living
near
pig
farms.

For
bacon
producers
to
be
able
to
raise
pigs,
they
then
 need
to
compensate
the
people
for
the
cost
of
externality
that
pig
farms
will
create.

 Therefore,
the
bacon
producers
will
now
bear
not
only
the
production
cost
but
also
 the
externality
cost,
so
that
production
will
then
ensue
where
the
full
social
cost
is
 equal
to
the
social
marginal
benefit.
 
 It
is
possible
to
not
make
any
Pareto
improvements
or
for
inefficiency
to
persist
if
 property
rights
are
poorly
assigned
or
poorly
enforced
or
if
there
are
transactions
 and
bargaining
costs.
 (d) Suppose
you
are
elected
to
represent
the
people
who
live
near
pig
farms
in
 negotiations
with
the
farmers.

Since
the
production
of
bacon
imposes
costs
 upon
your
group,
you
ask
the
farmers
to
reduce
their
output
of
bacon
below
the
 output
level
derived
in
part
(a).

What
is
the
most
you
would
pay
the
farmers
 (per
pound
reduction
in
bacon
output)?

How
much
would
you
have
to
pay
the
 farmers
(per
pound
reduction
in
bacon
output)
to
ensure
farmers
produce
the
 efficient
output
level?
 
 ANSWER:
 
 The
most
I
would
pay
the
farmers
would
be
$4
per
pound
reduction
in
bacon
output.

 Any
payment
higher
than
$4
is
not
commensurate
for
the
reduction
in
the
cost
of
 damage
to
me.

Moreover,
I
would
have
to
pay
the
farmers
$4
(per
pound
reduction
 in
bacon
output),
because
a
payment
lower
than
$4
is
still
not
enough
to
compel
the
 pig
farmers
to
fully
internalize
the
social
cost
and
produce
the
efficient
output
level.
 
 ...
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