EC102: CLASS 10
Christina Ammon
Notes on the Problem Set
 Two grades: One for multiple choice and one for Essay
questions – put most of the weight on essay for final grade
 For exam: would have all been saved by multiple choice
 In Exam: 40% multiple choice, 30% essay micro, 30% essay
macro
 Feedback:
• Have been given points for each subquestion (max 5)
• Even though format similar to mock exam, there was no exam style
marking scheme, so grades will vary across teachers
• If you have any questions: come to my office hour today 13:30-14:30
• Can give you more detailed feedback
Question 7h)
Use the model of monopolistic competition to discuss what
happens to domestic firms when foreign firms start selling in the
domestic market.
 Two effects of opening to international trade
• demand curve can become flatter
• Or damand curve can shift inwards
• some firms get displaced
Externalities
 When the activity of one entity/agent directly affects the
welfare of another in a way that is not captured in prices
 Two results
• Social costs ≠ private costs
• Social benefits ≠ private benefits
• Missing markets
 If there are externalities  Welfare Theorems no longer hold
Question 1
The London tube is one of the busiest undergrounds in the world.
Whenever a commuter takes the tube during rush hours, the
congestion increases. During rush hours an externality is present
because:
 The tube is a monopoly
 The tube is not properly managed
 There is a missing market
Question 2
S is supply, D is demand, SMC
is social marginal cost, PMC is
private marginal cost, MD is
marginal damage. At the level
of steel output X0 there is:
 Too much pollution because
SMC is below D
 Too little pollution because
SMC is above PMC
 Too much pollution because
SMC is above MD
 Too little pollution because
SMC is below D
The Coarse Theorem
 the efficient solution will be achieved through private
bargaining independently of who is assigned the ownership
rights, as long as someone is assigned those rights
Limits:
 Cannot identify sources of damage/agents that suffer
 Asymmetric information
 Bargaining costs
Question 3
S is supply, MR is marginal revenue,
SMC is social marginal cost, PMC is
private marginal cost, MD is marginal
damage. If the steel mill is price taker
and the ownership of clean air is
assigned to the forestry firm, the
largest bribe the steel mill would be
willing to pay for permission to
produce more than X* is:
•
•
•
More than enough to convince the
forestry firm to give permission
Just enough to convince the forestry firm
to give permission
Not enough to convince the forestry firm
to give permission
Question 3
Question 4
From time to time, used hospital waste, such as hypodermic
needles from unknown hospitals, wash up on beaches. This
creates an externality imposed on the public by the hospitals in
terms of dirty water and unsafe beaches. In this case the Coase
Theorem:
 Would lead to the correction of the implied externality
 Would not lead to the correction of the implied externality
Question 6
“It is not from the benevolence of the butcher, the
brewer, or the baker that we expect our dinner, but from
their regard to their own interest.”
(Adam Smith)
Question
 What is the consequence of that statement?
 Does this still hold if we have externalities?
 What about if the Coarse Theorem doesn’t hold
 Real life examples of externalities: Pollution
• Why does the Coarse Theorem not work here?
• Missing markets – how can the government intervene?
Correcting for Externalities
 What is a Piguvian Tax?
 A corrective tax that alignes the private marginal cost with the
social marginal cost
 Other ways to intervene:
• Regulation/legal interventions
• Creating a market/effluent fee
 What would be the optimal strategy in the case of pollution?
Question 5
If each pack of cigarettes smoked creates 68 pence of
externalities borne by other members of society (in terms of the
costs of cigarette smokers’ excess use of health services, of foetal
death, and of second-hand smoke), the situation can be corrected
by a Pigouvian of:
 68 pence
 32 pence
 34 pence
 16 pence