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Practice-Problems-3 - Practice Problems 3 Production and...

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Practice Problems 3 — Production and Congestion Externalities Instructor: Todd Sarver Econ 310-2, Fall 2011 These problems are for review and do not need to be turned in. I will post solutions over the weekend. I strongly encourage you to solve each problem before looking at its solution. 1 Production Externality Suppose that a honey farm (firm H ) is located next to an apple orchard (firm A ) and each acts as a competitive firm. Let a denote the quantity of apples produced and h denote the quantity of honey produced. Suppose the price per unit of apples is $3 and the price per unit of honey is $2. Assume that these prices are fixed, i.e., demand is perfectly elastic. The bees used to produce honey pollinate the apple tries, which reduces the costs of the apple orchard. Suppose the costs for these firms (in dollars) are determined by the following cost functions: c H ( h ) = h 2 / 100 c A ( a, h ) = a 2 / 60 - h (a) If these firms operate independently, what are the equilibrium quantities of these goods and what are the firms’ equilibrium profits? (b) What are the PE levels of production? Explain the method you use to solve for this quantity, and explain why the CE quantities are not efficient. (c) Compare the firms’ profits at the PE levels of production to their profits at the CE levels of production. Do both firms earn higher profits at the PE levels of production? Explain.
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