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# hw6ak - Homework#6 1 Consider the market for leaf-raking...

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Homework #6 1. Consider the market for leaf-raking services in Amherst in October. Individuals who rake their lawn (or pay someone else to rake their lawn) create a positive consumption externality by consuming leaf-raking services, because there are then fewer leaves blowing into their neighbors gardens. The Town of Amherst government estimates that, by raking his or her lawn (or hiring someone to rake it), an individual provides \$10 worth of external benefit to his or her neighbors. The following diagram depicts the market for leaf-raking services in Amherst in October. Output (Number of lawns raked per week) price (\$/lawn) 50 100 150 10 20 30 40 50 Supply Demand total benefit to society What is the market quantity of leaf-raking services per week in Amherst? 80 lawns per week In a free market, what would total surplus be? Consumer Surplus ½ * \$20 * 80 u \$800 U Producer Surplus U \$800 U Benefit to third parties due to externality U \$10 per lawn * 80 lawns u \$800 u \$2400 On the diagram on the previous page, draw a line representing the total marginal benefit to society as a whole from consumption of leaf-raking services. “Society’s” total benefit is the benefit to the consumer (measured by Willingness To Pay) U the \$10 externality What is the socially optimal quantity of leaf-raking services? 100 lawns per week If the town government attempts to use a Pigovian tax/subsidy approach to achieve the

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social optimum, how would it go about this? A subsidy places a “wedge” between the price the buyer pays and the price the seller gets - this is only different from a tax in that the buyer now pays less than the seller gets (another way of thinking about it is that the demand curve shifts upward; people are now willing to pay more to have their lawn mowed since they will get a “rebate” equal to the subsidy). By setting the subsidy equal to the value of the externality, we can achieve the optimal quantity; so, in this case, the subsidy should be \$10/lawn (as shown below). The
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hw6ak - Homework#6 1 Consider the market for leaf-raking...

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