Homework One
1.
What is social welfare? What is economic efficiency? Does market equilibrium always
imply economic efficiency? Why or why not?
2.
Explain the meaning of rivalry in consumption and excludability. Give some examples of
goods that are nonrival and nonexcludable, namely public goods.
3.
Arthur’s demand to reduce carbon emissions is MB = 20 – 2 Q, while Ronald’s demand
is MB = 15 – 3 Q, where Q is the amount of carbon reduced. The marginal cost of
reducing emissions is equal to $15 and is constant.
a. Draw Arthur’s MB curve and Ronald’s MB curve in a graph. Find the amount of carbon
reduction in a free market. Explain this outcome.
b. Draw the social demand curve (SMB) in the same graph. Find the socially efficient
amount of carbon reduction Q*.
4.
Suppose that a fertilizer factory’s marginal production costs are given by PMC = 10 + 3Q.
The production process of fertilizer generates a toxic waste, which imposes an increasingly
large cost on the residents of the town where it operates: the marginal external cost
associated with the Qth unit of production is given by MEC=6Q. The market demand for
their product is P=30-Q.
a. Draw a graph that demonstrate this case of externality. Clearly label all the axes and
curves. Find market equilibrium and social equilibrium.
b. Calculate the quantity of fertilizer produced by the market and the quantity that is socially
efficient.
c. Find the resulted welfare loss (DWL) on your graph. Explain why that area represents the
loss.
d. If the government wants to impose a Pigouvian tax on the output, how big of a tax is
needed to exactly internalize the externality?
e. What would happen to the price of fertilizer after imposing the tax proposed in d? Is this
price sending the right signal to consumer and producers?
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