(a) One finding of the study is that theaters attract traffic, which adversely affects the community. The city planner estimates that the cost to the community from the extra traffic is $5 per ticket. What kind of an externality is this? Why? This is a negative externality because the theatre will lead to uncompensated harm to the time commuters spend driving. (b) Graph the market for theater tickets, labeling the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output. Also show the per- unit amount of the externality. You should be able to do this. For an example, see Figure 10.2 on pg. 199 of your textbook. 6. The Pristine River has two polluting firms on its banks. Acme Industrial and Creative Chemicals each dump 100 tons of glop into the river each year. The cost of reducing glop emissions per ton equals $10 for Acme and $100 for Creative. The local government wants to reduce overall pollution from 200 tons to 50 tons. (a) If the government knows the cost of reduction for each firm, what reductions will it impose to reach its overall goal? What will be the cost to each firm and the total cost to the firms together? To reach its goal, the government will have reduce glop by 200 - 50 = 150 tons. The cost of reducing for Acme and Creative will depend upon how much of the burden of reduction the local government places upon each, which is likely to be a political decision. However, the efficient outcome would be for Acme to reduce glop emissions by 100 tons at a cost of 10 × 100 = $1 , 000 and for Creative to reduce glop emissions by 50 tons at a cost of 100 × 50 = $5 , 000. The total cost of reaching the goal in this case would be 1000 + 5000 = $6000 . (b) In a more typical situation, the government does not know the cost of pollution reduction for each firm. If the government decides to reach its overall goal by imposing uniform reductions on the firms, calculate the reduction made by each firm, the cost to each firm, and the total cost to the firms together. If the government makes each firm reduce pollution by 150 / 2 = 75 tons of glop each, the cost of reduction for Acme would be 10 × 75 = $750 and the cost of reduction for Creative would be 100 × 75 = $7 , 500 for a total cost of 750 + 7 , 500 = $8 , 250. 3 of 5
(c) Compare the total cost of pollution reduction in parts (a) and (b). If the government does not know the cost of reduction for each firm, is there still some way for it to reduce pollution to 50 tons at the total cost you calculated in part (a)? Explain. The total cost is greater in (b). Yes, the government can still reduce the level of pollution at the lowest possible cost by issuing permits for 50 tons of glop and letting Acme and Creative trade them. (Regardless of how the permits are given out initially, Creative will end up buying all of the permits because it is more costly for them to reduce their pollution.) 7. Both public goods and common resources involve externalities.
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