SQ3 Externalities
SQ3 Externalities
SQ3 Externalities
2
Section
Questions
1. For
each
of
the
following,
use
a
graph
to
show
the
private
market
equilibrium
and
how
it
differs
from
the
social
optimum.
a. The
market
for
natural
gas
when
the
process
used
to
extract
natural
gas
from
the
earth
leads
to
environmental
damage.
b. The
market
for
cigarettes
when
one
persons
consumption
of
cigarettes
can
harm
others
(because
of
second-hand
smoke).
c. The
market
for
solar
panels
for
peoples
homes
given
that
the
use
of
solar
panels
can
help
reduce
pollution
by
reducing
the
demand
for
electricity
from
coal
plants.
a.
MC
to
society
P
S
The
private
market
will
produce
too
much
P*
natural
gas
relative
the
social
optimum.
D
Q
QS
Q*
b.
P
S
The
private
market
will
produce
too
many
P*
cigarettes
relative
the
social
optimum.
D
MB
to
society
Q
QS
Q*
c.
P
S
The
private
market
MB
to
will
produce
too
few
P*
society
solar
panels
relative
to
the
social
optimum.
D
Q
Q*
QS
b. The
Lakeside
Caf
will
dump
garbage
into
the
lake
since
1100>1000.
c. The
Coase
Theorem
tells
us
that
the
social
optimum
will
be
achieved,
so
no
garbage
will
be
dumped
in
the
lake.
d. Camp
Canoe
could
pay
$150
dollars
to
the
Lakeside
Caf
every
day
to
stop
dumping
garbage
into
the
lake.
The
Lakeside
Caf
would
then
have
$1150
per
day
and
Camp
Canoe
would
have
$450
per
day
(so
they
would
both
be
$50
better
off
than
when
the
garbage
was
being
dumped
in
the
lake).
e. Camp
Canoe
would
simply
demand
that
the
Lakeside
Caf
stop
dumping
garbage
since
they
have
the
legal
right
to
do
so.
f. The
economist
wont
care.
In
either
case,
the
efficient
outcome
is
achieved.
g. Camp
Canoe
does
care.
They
will
get
$600
a
day
if
they
have
the
right
to
stop
The
Lakeside
Caf
from
dumping
garbage,
but
they
will
get
less
than
this
if
the
Lakeside
Caf
has
the
right
to
dump
garbage
because
Camp
Canoe
would
have
to
pay
them
to
stop.
4.
Suppose
the
supply
curve
for
jet
ski
rentals
on
Mission
Bay
is
given
by
P=2+0.1Q,
where
P
is
the
daily
rental
fee
per
jet
ski
in
dollars
and
Q
is
the
number
of
jet
skis
rented
each
day.
The
demand
curve
for
jet
skis
is
given
by
P=20-0.2Q.
a. If
each
jet
ski
imposes
a
$6
per
day
cost
on
others
(because
they
are
so
noisy),
by
how
much
will
the
equilibrium
number
of
jet
skis
rented
each
day
exceed
the
socially
optimal
number?
b. How
would
the
imposition
of
a
tax
of
$6
on
each
jet
ski
rental
affect
efficiency
in
this
market?
a. The
market
equilibrium
will
occur
where
2+0.1Q=20-0.2Q
=>
0.3Q=18
=>
Q*=60.
The
socially
optimal
quantity
occurs
where
8+0.1Q=20-
0.2Q
=>
0.3Q=12
=>
QS=40.
So
the
equilibrium
number
of
jet
skis
exceeds
the
social
optimum
by
20.
b. This
would
lead
to
the
efficient
outcome
since
the
tax
would
imply
that
marginal
cost
of
production
to
sellers
would
be
equal
to
the
social
marginal
cost
curve.
5. A
village
has
6
residents,
each
of
whom
has
an
accumulated
savings
of
$100.
Each
villager
can
use
this
money
either
to
buy
a
government
bond
that
pays
15
percent
interest
per
year
or
buy
a
1-year-old
llama,
send
it
onto
the
commons
to
graze,
and
sell
it
after
a
year.
The
price
the
villager
gets
for
the
2-year-llama
depends
on
the
quality
of
the
fleece
it
grows
while
grazing
on
the
commons,
which
in
turn,
depends
on
the
number
of
llamas
sent
into
the
commons,
as
shown
in
the
following
table:
Number
of
Price
Per
Llamas
on
the
2-Year
Commons
1
2
3
4
5
6
Old
Llama
122
118
116
114
112
109
Assume
the
villagers
make
their
investment
decisions
one
after
the
other,
and
their
decisions
are
public.
a. If
each
villager
decides
individually
how
to
invest,
how
many
llamas
will
be
sent
out
into
the
commons,
and
what
will
be
the
resulting
net
village
income?
b. What
is
the
socially
optimal
number
of
llamas
for
this
village?
Why
is
it
different
from
the
actual
number?
What
would
net
village
income
be
if
the
socially
optimal
number
of
llamas
were
sent
out
into
the
commons?
Why
might
it
be
difficult
for
the
villagers
to
agree
to
send
the
socially
optimal
number
of
llamas
into
the
commons?
c. Suppose
the
village
decides
to
auction
the
right
to
graze
llamas
on
the
commons
to
the
highest
bidder.
Whoever
purchases
the
right
to
graze
llamas
on
the
commons
can
resell
this
right
to
another
villager
in
the
future.
Assuming
the
villagers
can
both
borrow
and
lend
at
a
15
percent
annual
interest
rate,
how
much
will
the
right
to
graze
llamas
on
the
commons
sell
for
at
auction.
How
will
the
new
owner
use
the
right,
and
what
will
be
the
resulting
village
income?
a. See
the
table
below:
3
villagers
will
send
llamas
out
into
the
commons
and
3
villagers
will
buy
the
government
bond.
Total
village
income
will
be
3*$16+3*15=$93
b. See
the
table
below:
the
socially
optimal
number
of
llamas
is
1.
This
is
less
than
the
actual
number
from
part
a
because
in
part
a,
the
villagers
did
not
take
into
consideration
the
fact
that
when
they
send
a
llama
out
to
graze
on
the
commons
it
negatively
impacts
the
sales
price
of
all
the
other
llamas.
If
1
llama
were
sent
into
the
commons,
total
village
income
would
be
1*$22+5*15=$97.
c. The
right
to
graze
on
the
commons
will
sell
for
at
most
$46.67.
To
see
this
note
that
the
total
expense
of
grazing
on
the
commons
will
be
$100+X(1+.15),
where
X
is
the
price
paid
for
the
right
to
graze
on
the
commons
(which
has
to
be
borrowed
at
an
interest
rate
of
15
percent).
In
addition,
the
total
value
of
this
investment
at
the
end
of
the
year
will
equal
$122+X.
This
implies
that
the
net
income
from
purchasing
the
right
to
graze
on
the
commons
equals
($122+X)-[$100+X(1+.15)]=22-.15X.
Since
no
one
will
be
willing
to
purchase
the
right
to
graze
the
commons
unless
they
can
earn
at
least
$15
(what
they
can
earn
if
they
purchase
a
government
bond),
then
we
know
that
22-.15X15,
which
implies
that
X$46.67,
so
the
most
the
right
to
graze
the
commons
will
sell
for
is
$46.67.
The
new
owner
will
graze
1
llama
on
the
commons
and
total
village
income
will
be
6*$15
+0.15*$46.67=$97.
Number
of
Price
Per
Net
Total
Marginal
Llamas
on
2-Year
Income
Village
Income
the
Commons
Old
Per
Income
Llama
Llama
1
122
22
22
22
2
118
18
36
14
3
116
16
48
12
4
114
14
56
8
5
112
12
60
4
6
109
9
54
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