Tutorial Week 12

Question 1

Phoebe keeps a bee farm next door to an apple orchard. She chooses her optimal number of beehives by selecting the honey output level at which her private marginal benefit from beekeeping equals her private marginal cost.

a. Assume that Phoebe’s private marginal benefit and marginal cost curves from beekeeping ar normally shaped. Draw a diagram of them.

b. Phoebe’s bees help to pollinate the blossoms in the apple orchard, increasing the fruit yield. Show the social marginal benefit from Phoebe’s beekeeping in your diagram.

c. Phoebe’s bees are killer bees that aggressively sting anyone who steps into their flight path. Phoebe, fortunately, is immune to the bees’ venom. Show the social marginal cost curve from Phoebe’s beekeeping in your diagram.

d. Indicate the socially optimal quantity of beehives on your diagram. Is it higher or lower than the privately optimal quantity? Explain.

a. Assume that Phoebe’s private marginal benefit and marginal cost curves from beekeeping are normally shaped. Draw a

diagram of them.

Private MC

Private MB

X*

b. Phoebe’s bees help to pollinate the blossoms in the apple orchard, increasing the fruit yield. Show the social marginal

benefit from Phoebe’s beekeeping in your diagram.

Private MC

Private MB

X*

Social MB

X**

c. Phoebe’s bees are killer bees that aggressively sting anyone who steps into their flight path. Phoebe, fortunately, is immune to the bees’ venom. Show the social marginal cost curve from

Phoebe’s beekeeping in your diagram.

Private MC

Private MB

X* X**

Social MC

d. . Indicate the socially optimal quantity of beehives on your diagram. Is it higher or lower than the privately optimal

quantity? Explain.

Social MC Social MC

Private MC Private MC

Social MB

Private MB

Social MB

Private MB

X* X** Beehives X** X* Beehives

£/hive £/hive

Question 2

Suppose the supply curve of boom box rentals at a holiday resort is given by P=5+0.1Q , where P is the daily rent per unit and Q is the volume of units rented per day. The demand curve for boom boxes is P=20-0.2Q .

a. If each boom box imposes £3 per day in noise costs on others, by how much will the equilibrium number of boom boxes rented exceed the socially optimal number?

b. How would the imposition of a tax of £3 per unit on each daily boom box rental affect efficiency in this market?

a. If each boom box imposes £3 per day in noise costs on others, by how much will the equilibrium number of boom boxes rented

exceed the socially optimal number?

• Supply: P=5+0.1Q

• Demand: P=20-0.2Q

• Private equillibirum:

5+0.1Q = 20 – 0.2Q 0.3 Q = 15 Q=50

Social MC: Ps = 5 + 0.1 Qs + 3 = 8 + 0.1Qs

Demand: Ps=20-0.2Qs

8+0.1Qs = 20-0.2Qs Qs=40

b. How would the imposition of a tax of £3 per unit on each daily boom box rental affect efficiency in this

market?

• Imposition of the tax of £3 per unit would shift the private MC curve upward by £3 per unit, making it identical to the social MC curve.

• The socially optimal number of boom boxes would be rented, resulting in an overall increase in efficiency in this market.

QUESTION 3:

Suppose the law says that Jones may not emit smoke from his factory unless he gets permission from Smith, who lives

downwind. If the relevant costs and benefits of filtering the smoke from Jones’ production process are as shown in the table below, and if Jones and Smith can negotiate with one another at

no cost, will Jones emit smoke?

Jones emits smoke (£) Jones does not emit smoke (£)

Surplus for Jones 200 160

Surplus for Smith 400 420

• The most efficient outcome is for Jones to emit smoke, because the total daily surplus in that case will be £600 (=400+200), compared to only £580 =(160+420) when Jones does not emit smoke.

• Since Smith has the right to insist that Jones emit no smoke, Jones will have to compensate Smith for not exercising that right.

• If Jones pays Smith £30, each will be £10 better off than if Smith had forced Jones not to emit smoke.

Jones emits smoke (£) Jones does not emit smoke (£)

Surplus for Jones 200 160

Surplus for Smith 400 420

Question 4

John and Karl can live together in a two-bedroom flat for £500 per month, or each can rent a single-bedroom flat for £350 per month. Aside from rent, the two would be indifferent between living together and living separately, except for one problem: John leaves dirty dishes in the sink every night. Karl would be willing to pay up to £175 per month to avoid John’s dirty dishes. John would be willing to pay up to £225 to be able to continue his sloppiness.

a. Should John and Karl live together? If they do, will there be dirty dishes in the sink? Explain.

b. How, if at all, would your answer differ if John would be willing to pay up to £30 per month to avoid giving up his privacy by sharing with Karl?

Should John and Karl live together?

• A two-bedroom flat for £500 per month.

• Total cost of separate flats: £350 x 2 = £ 700 per month.

• Rent savings from sharing: £ 200

Meanwhile

• Least costly accommodation to the dishes problem: £ 175

• £ 200 > £ 175 They should live together

a. If they do, will there be dirty dishes in the sink? Explain.

• Karl’s alternative is to live alone, which would mean paying £350 per month and there is no dish problem.

• Since Karl would be willing to pay up to £175 per month to avoid John’s dirty dishes the highest monthly rent he would be willing to pay for the shared apartment is:

£ 350- £ 175 = £ 175

• Therefore, John would pay:

£ 500- £ 175 = £ 325 < £ 350 (This is a clearly better alternative for John than paying £ 350 to live alone)

How, if at all, would your answer differ if John would be willing to pay up to £30 per month to avoid giving up

his privacy by sharing with Karl?

• If living alone, John would pay £ 350

• The highest monthly rent he would be willing to pay for the shared apartment is:

£ 350- £ 30 = £ 320

This means that Karl would need to pay at least:

£ 500- £ 320 = £ 180

But the highest monthly rent Karl would be willing to pay is : £ 175

They should live separately

QUESTION 5 The table below shows all the marginal benefits for each voter in a small town whose town council is

considering a new swimming pool with capacity for at least three citizens. The cost of the pool would be £18

per week and would not depend on the number of people who actually used it.

Voter Marginal benefit (£/week)

A 12

B 5

C 2

a. If the pool must be financed by a weekly poll tax levied on all voters, will the pool be approved by majority vote? Is this

outcome socially efficient? Explain.

• The pool will not be built because with the requisite lump sum tax of £6 per voter per week, voters B and C will vote against it.

• This outcome is not socially efficient because the total benefits per week exceed the total weekly cost.

Voter Marginal benefit (£/week)

A 12

B 5

C 2

The town council instead decides to auction a franchise off to a private monopoly to build and maintain the pool. If it cannot find such a firm willing to operate the pool, then the pool project will

be scrapped. If all such monopolies are constrained by law to charge a single price to users, will the franchise be sold – and if so, how much will it sell for? Is this outcome socially efficient?

Explain.

• MC=0; • A monopolist’s profit maximising price is the price that maximises

total weekly revenue: That is a price of £12, serving only voter A . Revenue = £ 12

• Because If they set the price to serve at least two people: £ P = 5 (Voters A and B) Revenue = £ 10 < £ 12

• Because If they set the price to serve at least two people: £ P = 2 (Voters A,B, and C) Revenue = £ 6 < £ 12

• So Revenue (12) < Cost (18) no firm will be willing to operate the pool. Again, the socially efficient outcome is not achieved.

Question 6

Two customers, Smith and Jones, have the following demand curves for broadcasts of recorded opera on Saturdays:

Smith: Ps =12-Q Jones: PJ =12-2Q Where Ps and PJ represent marginal willingness to pay for

Smith and Jones, and Q represents the number of hours of opera broadcast each Saturday.

a) If Smith and Jones are the only broadcast listeners, construct the demand curve for opera broadcasts.

b) If the marginal cost of opera broadcasts is £15 per hour, what is the socially optimal number of hours of broadcast opera?

Smith: Ps =12-Q; Jones: PJ =12-2Q

• Since demand for a public good is the vertical sum of individual demands

– If Q 6 PJ < 0 or Jones will not pay.

– Only Smith pays.

Demand curve for opera broadcast is: P=12-Q

- If Demand curve for opera broadcast is: P=12-Q + 12- 2Q = 24- 3Q

Demand for a public good is the vertical sum of individual demands

• MC = 15 • MC intersects the total demand curve at the point where MC= 24-3Q • 15=24-3Q • 9=3Q • Q=3

£/hr 24 15 6 0 £/hr 12 0 £/hr 12 6 0

MC

D

DJones

DSmith

3 6 12 hours

6 hours

6 12 hours

QUESTION 7 If a regulator is seeking to regulate an industry with a large number of

competing firms, why might the problem of regulatory failure be smaller than if the industry were monopolised?

• If there are many firms in the industry, then it is more difficult to coordinate lobbying efforts between firms (the free rider problem), and firms may have a wider range of views as to what their interest are, due to differences in the firms’ situations.

• However, if the large number of firms forms a single industry association to defend the industry’s interests (and the firms’ interests), then the risk of regulatory failure may increase.

Basic revision form tutorial questions

• Game Theory – Dominant Strategy

– Nash equilibrium

– Ordering (Who plays first)

• Oligopoly – Courtnot model

• Each firm decides the quantity they produce

-

• Labor markets

- Value of marginal product

- VMP = wage

- Monopsonist

- Minimum wage

- If minimum wage is below the equilibrium wage, there will be no effect on decision

• International trade – Absolute advantage

– Comparative advantage (Opportunity cost)

– The possibly highest price in trading (based on the opportunity cost) (See question 3 in Week 11: Pizza and Beer)

– No trade equilibrium

– Trade equilibrium (international price/ import price)

– Tariff

– Quota

• Externality

– Positive/negative externality

– Coase theorem