Ch08-HW
1) Suppose a perfectly competitive
market for televisions is characterized by the following supply and demand
curves:
Demand:
P =
1000 – Q
Supply
(Marginal Cost to Firms): P = 3*Q
The
production process emits 100 lbs of CO2 pollution for every TV. The cost to the
environment is $2 per lb of C02.
A) Draw a supply and demand diagram, and
include the marginal social cost of TV production. Identify the equilibrium and
efficient outcomes.
EQ: 3Q
= 1000 – Q
4Q
= 1000
Q
= 250; P = 750
EFF: 3Q
+ 2*100 = 1000 – Q
4Q
= 800
Q
= 200; P = 800
B) The government imposes a pollution
tax of $2 per lb of CO2 emission. Firms invest in abatement technology, which
reduces emissions to just 10 lbs per TV. What is the new equilibrium outcome?
Is it efficient?
EFF: 3Q
+ 2*10 = 1000 – Q
4Q
= 980
Q
= 245; P = 755
Equilibrium requires S=D
Efficiency Requires MSC = MSB
Since S=MSC and D=MSB with this tax,
we know that the equilibrium is efficient.
FOLLOW UP QUESTION: HOW DOES PART B
AFFECT YOUR DIAGRAM?
2) You
are watching TV at a friend’s house in the village. Another friend calls and
asks you to pick her up and give her a car ride from Persson Hall.
A) Suppose your friend calls at 8 PM. What is the
marginal cost you incur by supplying a ride? Is the marginal social cost
different from this amount?
The MC would be the value of your time
spent watching the TV, plus the gas and ware on your car. The marginal social
costs would also include the additional CO2 you are releasing
into the air by driving, but this is probably negligible.
B) Suppose your friend calls at 3 PM. Compared to
part A, are there any additional private or social costs involved with
supplying a ride?
Yes; there are additional costs. Traffic
on the hill is ludicrously congested at 3PM with students loading and unloading
their friends. You will spend more time in the car (increased private costs).
Also, your presence imposes costs on other people who would like to drive on
the street unencumbered (e.g., your professors), so MSC increases as well.
Finally, the carbon emissions from longer idle times further destroy the
environment (another increase in MSC).
C) Do Colgate students supply an efficient number
of rides to and from Persson Hall during the day? What policy could ensure an
efficient outcome occurs? Would you support this policy?
Since MSC>MC, we know rides are
over-provided. For an efficient solution, drivers need to internalize the costs
they impose upon society. One solution would be to charge a toll to use the
street during peak hours. The university could give each student a fixed number
of permits to drive up the hill. Students who take frequent trips would then
have to buy permits from people who do not drive up the hill often. The
advantage of this policy is that the administration would not have to determine
the appropriate toll, but would rather distribute a total number of permits
equal to the “acceptable” level of rides during a semester.
FOLLOW UP QUESTION: WOULD IT BE EFFICIENT
FOR COLGATE TO CHARGE A TOLL AT ALL TIMES OF THE DAY?
3) When
banks offer loans, they face problems of adverse selection (attracting risky
customers) and moral hazard (people who refuse to repay the loan, once
received). What are microfinance firms? According to The
Economist, how have some reduced these problems?
Typically, banks spend a lot of money
screening potential borrowers to ensure that they are “good” people who want to
repay their loans. They also require collateral so that if a person will not
succumb to the temptation of electing not to repay. Such bank actions are
expensive.
Large banks often elect not to loan to
people in low-income countries since limited profit opportunity exists. More
over, when lenders are unfamiliar with borrowers on a personal level, as well
as their culture, screening and monitoring expenses rise. Sadly, this leaves
many people in the developing world without credit to buy homes or build
businesses.
Fortunately, the advent of Microfinance (or
Microcredit) firms has filled this need. In general, these firms offer small
loans to individuals in developing countries who don’t have access to
alternative credit. However, moral hazard and adverse selection remain high,
and can hinder firms’ efforts to provide credit.
ACCION developed a brilliant solution to this problem. Rather
than loan to individuals, ACCION lends to “groups of five
people that were collectively guaranteed... Each member of a group has a tiny
amount of money allocated to him or her, and as they collectively meet their
obligations the members establish a credit history that allows them to increase
the size of their loans.” In this way, borrowers police themselves and each
other. The stigma of failing to repay grows. People choose not to form groups
with “bad” borrowers. This occurs without additional expense to creditors.
If you are
interested in microfinance, here is an organization that might be fun for you: http://www.kiva.org/app.php
4) Many
Many companies offer health insurance
benefits for their employees. Thus, two answers are acceptable for this
question.
A) External benefits of weight
loss. When employees use health services
frequently, it raises healthcare costs for the firm. Obesity can lead to many
health problems. When individuals choose to pursue healthier lifestyles, they
reduce their dependence upon health services (private benefit of weight loss).
They also help reduce the cost of insurance plans for their employers, however.
If employers benefit when their employees choose to live healthy lifestyle but
do not compensate them for this behavior, people will live inefficiently
unhealthy lives. If employers pay for the external benefit of healthy living,
healthiness will improve.
B) Moral hazard. When a person has
health insurance, they might choose to live more risky (less healthy)
lifestyles. This causes insurance costs for employers to rise. Firms want low
health care costs, so they try to provide incentives for individuals to choose
healthier options.
5) Some professors require your attendance at
every class and will penalize you for each absence. Why does this policy make
more sense in theater than in economics?
Your private marginal cost of being
absent will equal the great wisdom your professor imparts to the class that
day. In theater, you also impose costs upon your classmates who depend upon
your presence to successfully practice their scenes. This externality implies
that you will be absent an inefficiently high number of times. Your theater
professors force you to internalize these costs by reducing your grade.
Learning in Economics, by nature, is
a much more individual experience. The difference between your marginal cost
and the marginal social cost of missing class is negligible. Since your
presence has very little effect on the performance of your classmates, there is
no externality needing to be internalized.
FOLLOW UP QUESTION: WHY DOES
COLGATE’S ADMINISTRATION PUNISH PROFESSORS FOR CANCELING
6) The interviewee in this Puget
Sound Business Journal article essentially makes up the word “clustering.”
What is the term for the economic phenomenon he is trying to describe? Why
might firms want to cluster?
There is a topic in Urban Economics
called “Economies of Agglomeration.” The idea is that many companies, similar
in nature, like to locate near each other. The presence of one firm creates a POSITIVE
EXTERNALITY for the other firms in the area.
Consider this: The