Problem Set 5

1. What is market failure and from what does it arise?

2. If people are rational, how can public choice result in government actions with benefits that are less than the costs?

3. Explain the nonrivalry and nonexcludability features of a pure public good. Why are both necessary for the good to be a pure public good?

4. Timblin Apartments has 100 resident who are all concerned about security. The table below gives the total cost per day of hiring a 24-hour security guard service and the marginal benefit per day to each of the residents.

a) Why is a security guard a public good for the residents of Timblin Apartments?
b) Why will no guards be hired if each of the residents must act individually?
c) Complete the last column of the table by computing the marginal benefit of security guards to all the residents combined.

5. Now suppose that the residents form an Apartment Council that acts as a governing body to address security issues.
a) What is the efficient number of guards? What is the net benefit of this amount?
b) Show that the net benefit is less for either one less guard or for one more guard than the net benefit for the efficient number of guards.
c) How might the Apartment Council pay for the guards it will hire?

6. The table below shows the citizens in a small democractic nation and their desired income tax rates. The political parties are trying to decide what income tax rate to propose.

a) Who is the median voter? What income tax rate will be proposed by the parties? Why?
b) Before the next election, Heather changes her mind and decides that she wants an income tax rate of 50%. What income tax rate will now be proposed? How does this tax rate compare with that in part (a)? If it is different, why is it different; if it is the same, why is it the same?
c) Heather continues to change her mind and before the third election she decides that she wants an income tax rate of 20%. Now what income tax rate will now be proposed? How does this tax rate compare with those in parts (a) and (b)? If it is different, why is it different; if it is the same, why is it the same?

7. "I don't see why the government would ever do anything that causes inefficiency. Inefficiency hurts the economy and I thought that the government would try to help us." Comment on this student's views and give an example of how the government might take actions that create inefficiency.

8. Art, Bob, and Charlie own a lake in Michigan that they use for recreational purposes. A mosquito abatement program will benefit all. Art place a value of $1, Bob places a value of $19, and Charlie places a value of $100 on a mosquito-free environment. A firm will spray the lake and charge each owner $35.
a) What decision would be reached under majority rule? Would the result be efficient?
b) What decision would be reached if Art, Bob, and Charlie could engage in costless negotiations? Could unanimity be achieved?

9. Suppose there are two classes made up of very similar students and students can choose which class they sign up for. In one class, each student receives the grade made on each test. In the other class, each student receives the class average as his or her grade. These policies are known by all. In what class would you expect the higher average grade? Explain.

10. An environmentalist argues that all pollution must be eliminated. How would you try to convince her that her position is both unreasonable and impractical?

11. Factory A produces 1000 tons of sulfuric acid at a cost of $10,000. For the people in the community, the production of 1000 tons of sulfuric acid causes an increase of $5000 in medical payments, a loss of $4000 in wages by being sick, and an increase of $1000 in dry-cleaning bills. What are the private and social costs of the 1000 tons of sulfuric acid? Show your work.

12. Take a monopolistic firm that produces a product that imposes external costs on the surrounding the community. Is this firm producing too much or too little?

13. Airport noise is certainly a negative externality. Why would people choose to live near airports?

14. A factory's production process creates sludge that pours into a river. This sludge makes it difficult to fish in the river, increasing the costs of the local fishermen by $4000. The factory can install a water filter system for $3500, and the fishermen can utilize a weighted fishing net system (to get under the sludge) for $2750. Both systems would remedy the sludge damage to the fishermen.
a) Suppose transactions costs are zero. If the factory is not liable and can continue to produce sludge, what outcome do you predict and why?
b) Suppose transactions costs are zero. If the factory is assigned liability for sludge damage, what outcome do you predict and why?
c) Now suppose transactions costs preclude the possibility of private bargaining between the factory and fishermen. If a pollution tax is levied on the factory with the proceeds given to the fishermen, then what outcome do you predict and why?
d) Discuss the results of parts (a), (b), and (c) in terms of the Coase Theorem.

15. Fishermen who use nets to catch tuna also sometimes net dolphins, which, because they are mammals, drown before they can be released. Currently, the price and quantity of tuna determined by the market does not take into account the cost to society of killing the dolphins (marginal external cost). Listed below are market demand and supply schedules for tuna as well as the marginal external social costs associated with dolphins killed in the process of catching tuna. All costs and values are listed in terms of dollars per pound of tuna.

a) What output and price would the free market generate? Why?
b) What is the socially optimal output and price? Why?
c) In order to obtain the socially optimal equilibrium, what would the appropriate per-pound tax on suppliers need to be? Of this tax, how much would consumers end up paying?

16. President Clinton wants stronger tax incentives to encourage more people to go to college and to remain in college longer. What are the economic arguments in favor of such a change in incentives? What are the arguments against it? Where do you come out on this issue and why?