ECON 110 Study Guide - Tax Rate, Gdp Deflator, Coase Theorem

When there is a positive externality in the market for a good, which of these statements is true? (choose all the correct answers)

a. The private market tends to produce less than is socially efficient.

b. The social planner sets marginal social benefit equal to firms' marginal cost.

c. Firms set their marginal private cost equal to the marginal external cost.

d. The private market tends to produce more than is socially efficient.

e. Production of this good should be banned

1. What type of externality (positive or negative)is described in

each of the following examples? Is the marginal social benefit

of the activity greater than or equal to the marginal benefit to

the individual? Is the marginal social cost of the activity

greater than or equal to the marginal cost to the individual?

Consequently, without intervention, will there be too little or

too much(relative to what would be socially optimal) of this

activity?

a. Mrs Chau plants lots of colourful flowers in her front yard.

b. Anna Crombie and Fritz, a popular clothing store, open ina lot of

small, attracting more shoppers who also visit other stores.

c. The fraternity next to your dorm plays loud music, keeping

you from studying.

d. Maija, who lives next to an apple orchard, decides to keep

bees to produce honey.

e. Justine buys a large SUV that consumes a lot of gasoline.

Suppose you work as research economist at the EPA. There are two firms that operate in a perfectly competitive market. This implies that each has the same marginal benefit curve, which in this case is horizontal at MB = $100. Each of the firms, however, has a different marginal private cost schedule: MPC1= 20+Q and MPC2=30+2Q Each firm’s production process creates externalities that are valued by society at $10 per unit output. a) Show that without government intervention, the firms’ profit maximizing outputs are Q=80 for firm 1 and Q=35 for firm 2, and the market price is $100. b) Now calculate the socially optimal level of output for each firm. c) Your boss knows that the firms are currently producing too much output and simply decides that all firms should cut their output by 15%. Show that this is an inefficient solution to this externality problem.