ECON 417 - Homework Assignment 1 - Chapters 1-4 Question 1 ✓ Solved

ECON 417 - Homework Assignment 1 - Chapters 1-4 Question 1

Suppose the production of a good X damages the environment (i.e. there is a negative externality). Using a diagram, show the dollar amount of inefficiency generated by the free market. Briefly explain how a corrective tax or subsidy policy could help reduce the inefficiency in the market.

Question 2 Suppose the consumption of a good M benefits not only the people who consume it but also the people who don’t consume it (i.e. there is a positive externality). Using a diagram, show the dollar amount of inefficiency generated by the free market. Briefly explain how a corrective tax or subsidy policy could help reduce the inefficiency in the market.

Question 3 Suppose that the consumption of canned beverages imposes an external cost on society of $1 per each can consumed. The market for canned beverages is competitive and the marginal cost of production is constant at $0.75 per can. A typical individual’s demand for this product is given as q = 500 - 40p. a) How many canned beverages would a typical individual consume? b) What is the socially optimal level of consumption for a typical individual? c) If there are a million people with the same demand for canned beverages what is the total net cost imposed on society from the overconsumption of canned beverages? d) Draw a detailed supply and demand diagram for the canned beverage market in part (c) above, and show the dollar amount of inefficiency generated by the free market.

Question 4 Suppose the market supply curve for automobile tires in the U.S. is QS = 2p - 20, and the market demand curve is QD = 220 - 4p. However, in producing tires the firms emit pollution that causes health damage to the local community, and the external cost on society is estimated to be $9 per automobile tire. a) What is the equilibrium level of automobile tire production? b) For the 60th automobile tire, what is the marginal benefit (MB) to consumers? c) For the 60th automobile tire, what is the marginal private cost of production (MPC)? d) For the 60th automobile tire, what is the marginal social cost (MSC)? e) For the 60th automobile tire, what is the marginal net loss to society? f) What is the socially optimal level of automobile tire production? g) What is the total net loss to society from the production of tires 49 through 60?

Question 5 Suppose firm A and firm B are solely responsible for all pollution in society. Pollution emissions are currently unregulated; however, the government would like to implement a policy that reduces total pollution emissions by 50 tons per year. Economists estimate the marginal abatement cost (MAC) for each firm as, MACA = 45,000 - 600eA and MACB = 15,000 - 200eB, where “e” measures the total amount of each firm’s annual pollution emissions in tons. a) What is the least expensive policy the government can implement to reduce total pollution emissions by 50 tons per year? b) How much would the policy in part (a) above cost each of the firms? c) Under the policy in part (a), how much would society spend to reduce total pollution emissions by 50 tons per year? d) Suppose that lobbyists for Firm B argue that the policy in part (a) is unfair because, in equilibrium, Firm B spends more money on reducing its pollution emissions relative to Firm A. Do you agree that the policy is unfair? Explain why or why not. e) Suppose that lobbyists for Firm B convince the government to change its policy and require each firm to reduce pollution emissions by an equal 25 tons. Under this new policy, how much would society spend to reduce total pollution emissions by 50 tons per year? f) What is the underlying economic intuition for the difference in your answers for part (c) and part (e) above?

Question 6 Suppose there are three families on an island and the ratio of their marginal benefits from a defensive wall around the island MBA : MBB : MBC is 5:2:1 at any thickness. For example, at a thickness of 0 feet, MBA = $1,000, MBB = $400, MBC = $200, and at a thickness of 5 feet, MBA = $500, MBB = $200, MBC = $100. The marginal cost (MC) of building an additional foot of thickness is $800. a) Draw the diagram, label the curves (lines), and show numbers. b) Would it be socially optimal to increase the wall thickness above 0 feet? Explain why or why not. c) What wall thickness is socially optimal?

Question 7 Suppose there are 4 families in society. Each have different preferences for a public good, and their demand curves are expressed as q1 = 3 - 15p, q2 = 30 - p, q3 = 15 - 1/2 p, and q4 = 5 - 19p. The marginal cost of producing the good is a constant $86. a) What is the equilibrium quantity in this market? b) What is the socially optimal quantity? c) What is the underlying economic intuition for the difference in your answers for part (a) and part (b) above?

Question 8 Suppose the following voting preferences shown in the table below. Each family (H, M, L, and D) votes between two choices (such as thick and thin) and then between two other choices.Choice H M L D First Thick Intermediate Thin Thin Second Intermediate Thin Intermediate Thick Third Thin Thick Thick Intermediate a) With H, M, and L voting, but not D, what happens? Why? b) With H, M, and D voting, but not L, what happens?

Question 9 Suppose a factory would be built in one year (year 0) and last only a year (year 1). The construction cost in year 0 would be $100,000 financed by borrowing and the profit in year 1 would be $120,000. a) Should the firm build the factory? Explain why or why not. b) Suppose the factory lasts two years instead of one, and the profit is $60,000 in year 1 and $72,000 in year 2. Should it be built? Explain.

Question 10 Suppose a city has 20,000 residents who ride the subway 200 times per year at a cost of $1.50 per trip. The only alternative is a bus that takes 10 minutes longer and costs $0.50 per trip. The city is considering renovations of the subway system that would reduce the trip time by 5 minutes, but fares would increase by $1.00 per trip to cover the renovation costs. Assume that the fare increase and reduced travel time both take effect next year and last forever, and that the interest rate is constant at 8%. a) Should the city renovate the subway? Explain why or why not. b) To justify the $1.00 increase in subway fares based on cost-benefit analysis, the renovations would need to reduce the subway trip time by how many minutes?

Paper For Above Instructions

The relationship between production, consumption, and the environment is embedded in economic theory, specifically in the areas of externalities and public goods. Externalities occur when the actions of individuals or firms positively or negatively affect third parties, which is often not taken into account in market transactions. In this assignment, we will explore the inefficiencies caused by both negative and positive externalities, the social costs and benefits linked to goods and services, and the policies that could mitigate these inefficiencies.

Negative Externalities: The Case of Good X

The production of good X illustrates a classic example of a negative externality, where the production process damages the environment. In a free market, producers only consider their private costs, ignoring the external costs imposed on society. This can be depicted through a supply and demand diagram:

In the diagram, the equilibrium price and quantity are determined by the intersection of the supply and demand curves (P1, Q1). However, the social cost (MSC) is higher than the private cost (MPC) due to the environmental damage. The dollar amount of inefficiency can be represented by the area between the demand curve and the social cost curve, leading to an overproduction of good X compared to the socially optimal level (Q2). Implementing a corrective tax, equal to the external cost, could align the private cost with the social cost, leading to a more efficient allocation of resources. This tax would discourage excessive production and mitigate environmental damage.

Positive Externalities: The Case of Good M

Conversely, good M presents a scenario where consumption generates positive externalities. Consumers benefit not only themselves but also third parties who do not consume the good. Similar to good X, we can create a diagram to illustrate this positive externality:

The market equilibrium (P1, Q1) fails to account for the additional benefits to society, resulting in underconsumption (Q2). The area between the social benefit curve and the demand curve represents the dollar amount of inefficiency. A subsidy could help promote the consumption of good M, effectively decreasing the gap between the social and private benefits, thereby encouraging a socially optimal level of consumption.

External Costs of Canned Beverages

In Question 3, we consider canned beverages that impose an external cost of $1 per can consumed. An individual’s demand is given by q = 500 - 40p, and the marginal cost of production remains constant at $0.75. By setting the demand equal to the price, we find:

Individual Consumption:At equilibrium, setting P = 0 (to find maximum consumption), total quantity consumed would be:

q = 500 - 40(0) = 500

Since there are 1 million individuals, the external costs borne by the entire population from overconsumption is significant. The socially optimal level of consumption can be derived when both the external cost and marginal cost are considered.

Analysis of Automobile Tires

Similarly, the market for automobile tires provides insights into marginal benefits (MB) and costs (MPC, MSC) caused by pollution. Through calculations, one can derive the equilibrium production level while accounting for the external costs linked to health damage in the local community. Understanding these correlations helps policymakers identify effective intervention strategies to align social and private interests.

Pollution Reduction Policies: Firms A and B

When analyzing pollution reduction strategies, considering marginal abatement costs is crucial. The least expensive policy approach should focus on equalizing the costs faced by firms, creating financial incentives to lower emissions effectively. Different policies, such as equal reduction targets versus cost-effective measures, elucidate differing societal burdens and fairness in distribution.

Public Goods and Voting Preferences

Examining the allocation of public goods through collective decision-making highlights the importance of individual preferences on social welfare. Utilizing voting patterns can reveal insights into preferences for thickness in defensive structures, shaping how society collectively decides on efficient outcomes.

Cost-Benefit Analysis: Subway Renovation

Lastly, in assessing urban infrastructure investments like subway renovations, we need to consider long-term societal benefits versus immediate costs. The cost-benefit analysis must quantify reduced travel times against fare increases to advocate for efficient transit systems that improve quality of life sustainably.

Conclusion

Understanding and addressing externalities is a fundamental aspect of economic policy. By articulating the concepts of marginal social cost and marginal private cost, along with employing corrective measures, we can foster an environmentally and socially optimal marketplace. This assignment exemplifies the myriad ways in which economic theory can inform decision-making, promoting a balance between individual actions and societal wellbeing.

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