1. What is meant by the Pareto Efficiency of an allocation of resources? How unique is it for an allocation of resources to be Pareto efficient? What consideration is overlooked by Pareto efficiency? What does the First Theorem of Welfare Economics assert?
2. What is the distinction between a pecuniary externality versus a real (or technical) externality? Give an example of an interaction that constitutes a pecuniary externality. Give an example of an interaction that constitutes a real externality.
3. Imagine a price-taking producer whose production causes a real, negative externality. Draw a diagram to depict the economic outcome in this case, and how this differs from what is the socially optimal outcome. Also, depict Pigou's tax proposal to correct the externality.
4. Acme Charcoal is a charcoal producing company in Cleveland. Its total cost function is
C(QA) = 5 + 20QA + 2QA2, where QA is charcoal production per week in thousands of tons.
a) What is the formula for Acme's marginal cost function?
b) This is the nineteenth century, and no pollution control laws have yet been passed in the US. If charcoal sells in Cleveland for $420 per thousand tons, how much charcoal will Acme produce?
Clearview is an eyeglass company located near Acme Charcoal in Cleveland. Clearview's production of eyeglasses is negatively affected by the smoke from Acme's production of charcoal. Clearview's total cost function to produce eyeglasses is
C(QE) = 60QE + 2QE2 + 1.5QA where QE is Clearview's weekly production of eyeglasses and QA is Acme's weekly production of charcoal in thousands of tons.
c) What is the extra cost to Clearview from an additional thousand tons of charcoal production by Acme?
d) Eyeglasses sell for $160 per eyeglass. How many eyeglasses would you predict that Clearview produces per week?
e) How much profit do Acme and Clearview each earn in this situation?
f) What is the socially optimal level of production of charcoal by Acme? Explain the reason for your answer.
g) If Acme produced the level of production given in your answer to (f), how much would Clearview choose to produce?
h) Given your answer to (f) and (g), how much profit would Acme and Clearview each earn in that situation?
i) How might the outcome in (f) and (g) be brought about according to Pigou?
j) How might the outcome in (f) and (g) be brought about according to Coase if (I) the law makes Acme legally liable for damages resulting from his pollution, or (II) the law imposes no liability on Acme for the consequences of his pollution?
5. The Burnbright Electric Power Company has a coal-fired power plant located in Northern Utah. Consider three alternative scenarios.
(i) The air pollution generated by burning coal at the Burnbright plant doesnâ't cause any pollution, but the trucks that ferry coal to the plant on a daily basis cause traffic congestion for the residents of a small town nearby.
(ii) The air pollution generated by burning coal at the Burnbright plant causes severe haze to occur at the Grand Canyon National Park during the summer season.
(iii) The air pollution generated by burning coal at the Burnbright plant contributes to worldwide greenhouse gas emissions, which contribute to global warming over the next fifty years.
a) Do you think it is likely that Coasian bargaining will take care of the externality and generate a Pareto-efficient allocation of resources without any need for government intervention to control the externality? Answer for each case separately, and explain the reasons for your answer.
b) What are transaction costs? How might they enter the picture in each case? How could they affect the outcome of Coasian bargaining?
