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Midterm 1 solutions

Midterm 1 solutions - Economics 131 Fall 2013 Midterm 1 1(8...

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P SMC D Q S = PMC A B C F E D H K T L MD M N R U G Q M Q * W 0 P M P * Economics 131 – Fall 2013 Midterm 1 1. (8 points) Consider the market for a good Q when there is an externality that creates marginal environmental damages given by MD. D is demand, S is supply (private marginal cost to producers), and SMC is social marginal cost. The dashed lines divide up the labeled areas. Answer using areas on the graph, except for part (d) which is short answer. a. (2 points) How much does total social surplus increase if we start at Q M and move to Q*? As we move from Q m to Q*, total social surplus increases by the amount F+E. Geometrically, F+E is identical to U-D-K (both answers received full credit). U is the environmental gain as we move to Q* and D+K is the lost producer and consumer surplus. b. (2 points) What is the total social surplus at Q*? Total social surplus is the area between SMB and SMC, which is A+B+G. This is equal to [CS] + [PS] - [environmental damage] = [A] + [B+C+G+H+R] - [R+T]. c. (2 points) Now consider a ban on production of Q (moving from Q M to Q=0). What is the total environmental benefit of this ban?
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