ECON361 Study Guide - Quiz Guide: Opportunity Cost, Marginal Cost, Deadweight Loss

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ECON361 online Spring 2016 Problem Set Two Answers Page 1
Cost Benefit Analysis & Project Evaluation Econ361 Online
Econ 361 Online Problem Set Two Answers
This document articulates answers to questions in Problem Set One.
1. Answers
a) The net cost to society is the deadweight loss caused by the increased toll and the
resulting fall in the number of cars using the highway. The value of this deadweight loss is
(.5)(.50-.40)(50,000-40,000) = $500. The increased toll paid by the remaining drivers --
(.50-.40)(40,000) -- can be viewed as a transfer from the drivers to the government.
b) Part of the government's $25,000 savings from purchasing less concrete are offset by a
reduction in surplus received by the producers of concrete. This loss can be computed as
the triangular area above the supply curve and between the old and the new quantities
purchased by the government. Consequently, the size of the annual loss to producers of
concrete is (.5)($25-$24.50)(1,000) = $250. Thus, the social value of the savings that
results from the government using less concrete is $25,000 - $250 = $24,750.
It would appear, therefore, that the reduction in the government's budgetary expenditure
provides a good approximation of the social value of the savings that results from the
reduced purchases of concrete and that the use of shadow prices in this instance is not
really necessary.
Note that the government, as well as non-government buyers of concrete, also receive gains
from the 50 cent reduction in the price of concrete. However, these gains are more than
offset by reductions in the surplus of the producers of concrete. In estimating the effects of
the 50 cent reduction in price, it is the difference between the loss of producer surplus and
the gain in consumer surplus that must be measured.
2. a)
A
MSC = $35
MPC = $25
Q
P
B
C
8000
10,000
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ECON361 online Spring 2016 Problem Set Two Answers Page 2
b) The tax induces the producers to produce the quantity where MSB = MSC.
The change in quantity due to the tax can be calculated using the elasticity of demand.
εd =(∆Qd /P)(P/Q) or, -0.5 =(∆Qd /10)x (25/10,000) or, ∆Qd = -2,000
New quantity produced with tax:
Q = 10,000 -2,000 =8000
With tax of $10 per oil change,
Change in Consumer Surplus ∆CS = -(A + B )
= -(10x 8,000 + 0.5 x 10 x 2,000) = -$90,000
Change in Government revenue ∆GR = A = 10x 8000 = $80,000
Benefit from reduced air pollution= B+C = 2,000x10 =$20,000
Annual net benefit of this tax = -90,000 + 80,000+20,000 = $10,000
3. a)
Without government intervention, the natural monopolist chooses the output level where
MC= MR. In terms of figure 1, quantity Qm and price Pm is chosen by the monopolist. The
efficient quantity is where MC=P or QC shown in figure 1. The loss in social surplus due to
having a monopoly instead of a perfectly competitive market is given by the area abc .Thus,
area of the triangle abc shows the deadweight loss that results from a natural monopoly in
this market.
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