Problems
1. Please refer to the diagram to answer the following questions:
a. Calculate the consumer surplus at the equilibrium price.
b. Calculate the producer surplus at the equilibrium price.
c. If the government imposes a $70 price ceiling, calculate the new producer surplus.
d. If the government imposes a price floor of $120, calculate the new consumer surplus.
2. Generally speaking, competitive market produces less than socially optimal quantity of a good in the presence of a positive externality. On the other hand, it produces more than socially optimal quantity of a good in the presence of a negative externality.
Explain the statement above using your own examples. You may use the diagrams similar to those in the slides to make your case. Your answer should clearly show the claim made above.
3. There are three industrial firms in Happy Valley. The following table describes the current pollution created by them and the cost of reducing pollution by 1 unit to each firm
|
Firm
|
Initial Pollution Level (in CO2 tons)
|
Cost of reducing pollution by 1 unit (in $)
|
|
A
|
70
|
20
|
|
B
|
80
|
25
|
|
C
|
50
|
10
|
The government would like to reduce total pollution to 120 units, so it gives each firm 40 tradable pollution permits.
a) Who sells permits and how many will they sell? Who buys permits and how many will they buy?
b) Briefly explain why the sellers and buyers will do so?
c) What will be the total cost of reducing pollution? (For simplicity, assume that the price of the permit will be the average of the costs of firms engaging in trade)
d) How much higher would the costs of pollution reduction be if the permits were not tradable?
4. Private solutions to externalities:
Coase Theorem suggests that in absence of transaction costs and clearly defined property rights, private parties can solve the problem of externalities on their own. Use this idea to answer the following questions:
Bradley (aka Brad) and Angelina (aka Angie) are roommates. Angie recently rescued a python and currently keeping it as her pet. She named it Jane. Brad dislikes pythons and is fairly unhappy with current situation.
a) Suppose that the current cohabitation policies state that Angie has a legal right to keep pets (including pythons). Angie values keeping Jane as her pet at $600, Brad estimates the cost of inconvenience caused by Jane to him to be $800. What is the socially efficient outcome here? What will be the private outcome? Will the private outcome be same as social outcome?
b) Suppose that the current cohabitation policies state that Angie has a legal right to keep pets (including pythons). Angie values keeping Jane as her pet at $800, Brad estimates the cost of inconvenience caused by Jane to him to be $600. What is the socially efficient outcome here? What will be the private outcome? Will the private outcome be same as social outcome?
c) Suppose that the cohabitation policies change and now Brad has a legal right to deny any pets (including pythons). Angie values keeping Jane as her pet at $1000, Brad estimates the cost of inconvenience caused by Jane to him to be $800. What is the socially efficient outcome here? What will be the private outcome? Will the private outcome be same as social outcome?
d) What are some of the problems working out these solutions in real life?