Problem Set 4 Answer Key

1. From Parkin, page 361:

Parkin #1:
a) Wage for low skilled workers= $5
b) Employment of low skilled workers= 5000 hours

Parkin #2:
a) Wage for high skilled workers = $8
b) Employment of high skilled workers= 6000 hours

Parkin #3:
a) Wage for high skilled union workers = $10
b) Wage differential = $10 - $5 = $5

Parkin #4:
a) Wage for low skilled workers = $6
b) Employment of low skilled workers = 4000 hours

2. Restrict imports, support minimum wage laws, advocate consumers to buy union made products, raise the MP of union members.

3. Any wage over the equilibrium wage of $8 will cause an excess supply of workers--in other words, unemployment. By raising the wage to $12 per hour, the union is essentially trading off some jobs for the higher wages.

4. Differences in jobs, discrimination, differences in human capital, and differences in degree of specialization.

5. Immigration into the US will tend to lower US wages (due to higher labor supply here) and raise wages in other countries (due to lower labor supply there). However, the effect on US wages is not large because there are offsetting effects. Immigrants may also increase the demand for labor because they buy goods and services here also. Second, immigrants bring capital with them, which makes US workers more productive. Third, immigrants may be a complement rather than a substitute for high skilled US labor.

6. We did this one in class.

7. Becker argues that since prejudiced based discrimination is costly to businesses, businesses that do discriminate will eventually lose market share to those that don't discriminate.

8. This one is straight out of your notes.

9. Imagine that the comparable worth law requires both building inspectors and nurses to be paid $10 per hour. At this wage there will be a shortage of building inspectors. Some building inspectors will leave this labor market and look for a better paying job elsewhere. Those that leave are likely to be highly skilled workers. Those that remain as inspectors are likely to be low quality inspectors. Meanwhile, the nurses market will be experience a surplus. Hospitals will be able to choose only the most highly skilled nurses, leaving the less skilled nurses out of luck.

10. Market failure is the inability of a private unregulated market to attain efficiency, where efficiency is defined as marginal social benefits = marginal social cost. Three broad problems can lead to market failure: monopoly, public goods, and externalities.

11. Parkin #1 page 407
a) 3500 gallons per day.
b) The marginal cost of 3500 gallons of capacity is $40, which is the amount that must be paid in taxes.
c) 3500 gallons
d) Bureaucrats will attempt to build the system that maximizes the budget, that is, a system large enough that total benefit equals total cost. The marginal benefit and marginal cost curves illustrated do not directly measure the total benefit and cost. Thus all we can say is that the system that will be built will exceed 3500 gallons of capacity and will be the size such that the total benefit equals the total cost.

12. Rational ignorance suggests that people will not spend a lot of time and money worrying about every piece of legislation debated by governments. Special interest groups, however, will attempt to manipulate the political process to their advantage in order to secure concentrated benefits at taxpayer expense.

13. Bring this one up in a bar some night if you want a good debate.

14. Mosquito abatement program.
a) Under majority rule, only Charlie would vote in favor of the abatement program (since he values the program at $100, which is more than the cost to each owner of $35). Thus, the abatement program would not be approved. From society's point-of-view this would be inefficient since the total value of the program to the three guys ($120) is greater than the total cost ($105).
b) Unanimity could be reached by having Charlie subsidize Art and Bob's "tax bill." Assuming Art and Bob are willing to pay their values, Charlie could pay $34 on behalf of Art and $16 on behalf of Bob in order to pay for the abatement program. All parties would thus benefit.

15. What do you think? What would Coase think?

16. The class in which students earn their own grades will have the higher class average. The class in which students earn the class average as their grade will attract a lot of free riders. The free riders are likely to be (how should I say) academically-challenged, thereby ensuring an overall lower class average.

17. How would you argue?

18. Private costs = $10,000
External costs = $5000 + 4000 + 1000 = $10,000
Social costs = private + external = $20,000

19. On the one hand, a monopolist is inefficient because it tends to underproduce. On the other hand, a firm that generates a negative externality tends to overproduce its product. Combining these two yields an uncertain outcome since the two effects may tend to offset each other to some degree.

20. Think carefully about it.

21. Fishermen and sludge.
a) The fishermen will buy the nets at a cost of $2750.
b) The factory will buy the nets for the fishermen at a cost of $2750.
c) The tax is likely to be set equal to the damage done by the sludge to the fishermen, namely, $4000. Given this potential tax liability, the factory will try to minimize its costs by avoiding the tax. Since the factory is precluded from bargaining with the fishermen as in part (b), they will be unable to buy the net system. The next best option is to install the water filter system at a cost of $3500 (which is better than paying $4000 in taxes).
d) As Coase would argue, the outcomes in parts (a) and (b) are identical: as long as property rights are well-defined and transaction costs are low, private bargaining will result in the most efficient outcome. In this case, efficiency requires that the nets be used. However, in part (c), transactions costs were high enough to prevent bargaining so that only a "second best" outcome prevailed.

22. Tuna.
a) Free market price is $3.00 and output is 6,000,000 tuna where (private MB = private MC)
b) Socially optimal price is $4.50 and output is 3,000,000 tuna (where MSB = MSC)
c) Tax would be equal to the marginal external cost of tuna at the optimal output, namely, $2.25. Consumers would end up paying $1.50 of the tax (the change in market price from part (a) to part (b)).

23. Parkin questions page 445-446:

Parkin #1:
a) 3 tons
b) 3 tons will be dumped at $100 each.
c) 3 tons will be dumped at $100 each

Parkin #2:
a) Tax on the first ton = $50; tax on the second ton = $75; tax on the third ton = $100; and so on...
b) Tax equals the marginal cost of dumping.

Parkin #3:
a) 3 tons
b) Suppose that the manufacturer and farmer each recieve 1.5 permits. The manufacturer will buy the permits from the farmer. If only a single price is allowed, the maximum the manufacturer will pay is $100 per ton and the minimum the farmer will accept is $100. Hence, the price is $100.
c) The key is the marginal benefit and marginal cost schedules given in problem #1 above.

24. Parkin #4 page 446.
a) Price = $4000; Quantity = 30,000 students
b) The socially efficient quantity of students is 50,000. The tutition must be $2000.

25. This question is really good fodder for a bar debate.