a) Show the effect of a € 0.50 per cornet subsidy on the demand curve for ice cream cornets, the effective price paid by consumers, the effective price received by sellers and the quantity of cornets sold. The effect of a $0.50 per cone subsidy is to shift the demand curve up by $0.50 at each quantity, because at each quantity a consumer's willingness to pay is $0.50 higher. The effects of such a subsidy are shown in Figure 12. Before the subsidy, the price is P1. After the subsidy, the price received by sellers is PS and the effective price paid by consumers is PD, which equals PS minus $0.50. Before the subsidy, the quantity of cones sold is Q1; after the subsidy the quantity increases to Q2. b) Do consumers gain or lose from this policy? Do producers gain or lose? Does the government gain or lose? Because of the subsidy, consumers are better off, because they consume more at a lower price. Producers are also better off, because they sell more at a higher price. The government loses, because it has to pay for the subsidy. c) Does a subsidy lead to a deadweight loss? Explain. Yes it does, the deadweight loss of the subsidy is the amount by which the cost of the subsidy exceeds the gains in consumers' and producers' surpluses. Deadweight Loss = (1/2)(amount of tax or subsidy)*Change in Output.
8. Give an example of a positive production externality and an example of a negative production externality. And give an example of a positive consumption externality and an example of a negative consumption externality. (Different from the ones we have seen in class or in the textbook). Examples of positive externalities include the restoration of historic buildings, research into new technologies, and education. Examples of negative externalities include pollution, barking dogs, and consumption of alcoholic beverages. Market outcomes are inefficient in the presence of externalities because markets produce a larger quantity than is socially desirable when there is a negative externality and a smaller quantity than is socially desirable when there is a positive externality. 9. There are at least three negative externalities associated with driving. a) Which are these externalities? Does this explain why petrol is taxed so heavily? 1. Congestion: too many cars on the road cause traffic. By taxing petrol, lesspeople drive and use other types of transport, so the traffic decreases. 2. Accidents: people driving large cars such as 4x4 put the rest of the peopledriving typlical cars in risk because in an accident, people driving typical carscan die due to the size and power of the large car. The petrol tax is and indirectway of making people pay when they large, petrol-thirsty vehicles impose riskon others. 3. Pollution: carbon emission increases by fuel burning so a tax on petrolreduce the quantity consumed of it, that is, less emission of toxic gas b) Illustrate the market for petrol, labelling 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.
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