test3_solns

# test3_solns - Department of Economics University of Toronto...

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Page 1 of 7 Department of Economics Prof. Gustavo Indart University of Toronto March 7, 2008 ECO 100Y – L0201 INTRODUCTION TO ECONOMICS Midterm Test #3 LAST NAME FIRST NAME STUDENT NUMBER INSTRUCTIONS : 1. The total time for this test is 50 minutes. 2. This question booklet has 7 (seven) pages. 3. Answer all questions in the space provided. If space is not sufficient, continue on the back of the previous page. 4. Aids allowed: a simple, non-programmable calculator only. 5. Use pen instead of pencil . DO NOT WRITE IN THIS SPACE Part I 1. /12 Part II /20 2. /16 3. /12 TOTAL /60 SOLUTIONS

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Page 2 of 7 PART I (40 marks) Question 1 (12 marks) Consider the market for lumber, which we assume here to be perfectly competitive. The diagram below shows the initial equilibrium, where MC P is the private marginal cost, MB P is the private marginal benefit, and MB S is the social marginal benefit. 13 12 15 a) Suppose that for each unit of lumber produced, the firm also generates \$5 of damage to the environment. Draw the social marginal cost (MC S ) curve in the diagram. (4 marks) b) What is the allocatively efficient level of lumber output? Briefly explain when allocative efficiency is achieved . (4 marks) The allocative efficient level of lumber output is 12 units. The allocative efficient level of output is achieved when MB S = MC S . In the market equilibrium MB P = MC P , but MC S > MC P and thus MC S > MB S = MB P . Therefore, Q is too large from the social point of view and must decrease to achieve allocative efficiency. c) What can the government do to have the lumber industry producing the allocatively efficient level of output? Briefly explain . (4 marks) Since MC S > MC P at Q = 15, the government should impose a unit-tax of \$5 to the producer in order to increase its private marginal cost to the level of the social marginal cost. This will cause the S curve to shift up and coincide with the MC S curve. In this new equilibrium, output would be Q = 12 and consumers would pay a price of \$13 which covers the MC S equal to the before-tax MC P of \$8 plus the unit-tax of \$5. Note that the same result could have been obtained if the unit-tax of \$5 had been imposed on the
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## This note was uploaded on 06/09/2010 for the course ECO ECO100 taught by Professor Inheart during the Spring '09 term at University of Toronto.

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test3_solns - Department of Economics University of Toronto...

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