week -6 economics

questions_-microeconomics_homework_6 x

ECON

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Homework Assignment 6

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Read these instructions carefully!

· Carefully answer each of the questions below.

· You can write or type your answers for the questions EXCEPT ANY GRAPHS MUST BE COMPLETED BY HAND (NOT USING THE DRAWING TOOLS IN WORD OR ANY OTHER PROGRAM).

· Please put your name and PSU ID number at the top of the 1st page.

· You may use as many sheets of paper as you need.

· When you are finished, scan your entire document (including the parts you typed and the parts done by hand).

· Save the file on your computer (.PDF format preferred) and then upload it to the ANGEL drop box for this homework assignment.

1. (

20

points)

35

5

Quantity of the public good	Willingness to pay of person 1	Willingness to pay of person 2	Society’s willingness to pay
1	6 5		3 5	100
2	55	25	80
3	4 5	15	60
4		5	40
20	0	20

The table above shows the willingness to pay for various units of a public good for the only two individuals in a society. The willingness to pay is the willingness to pay per unit of the public good. For example, person 1 is willing to pay $55 per unit of the public good for two units. To put it another way, if the price to person 1 of two units of the public good is $55, then person 1 would want to purchase 2 units of the public good. (If you were to plot person 1’s willingness to pay for the public good with quantity on the horizontal axis and willingness to pay on the vertical axis, it would look like a demand curve, and that is exactly what it is.) Fill in the column “Society’s willingness to pay.” Then draw a graph of society’s demand for the public good.

Society’s willingness to pay is combination of willingness of person 1 and person2 assuming there are only two persons in a society. So, for quantity 1, it is 65+35 = 100

The demand curve for society’s demand for the public good is shown above. The slope of this curve gives the elasticity of demand.

2. (20 points) Bob and Dexter share a dorm room. Bob is a smoker but Dexter does not smoke. There are no laws that prohibit smoking in the dorm rooms. The benefit of smoking is worth $250 to Bob, but the smoke imposes a $500 cost on Dexter. How might the Coase theorem be used to achieve an efficient outcome in this situation? In your answer, be sure to define the Coase theorem, and the conditions under which the Coase theorem may work.

The theory has described the Coase theorem as the 

economic efficiency

 of an economic 

allocation

  in the presence of 

externalities

. The theorem states that if trade in an externality is possible and there are no 

transactions costs

, and bargaining will lead to an efficient outcome regardless of the initial allocation of property. 

The facts given in the question are

Benefit of smoking to Bob= $250

Cost of smoking on Dexter=$500

Case 1

If Dexter has the right that he lives in clear healthy environment so Cost of smoking must be paid by Bob.

Bob will pay to Dexter = $ 500

Bob buy new filter that helps in clearing environment= $250

Outcome: Bob must install filter.

Case 2:

Bob has the right to pollute the environment and Cost of smoking must be paid by Dexter.

Dexter will pay to Bob= $500

Dexter buy new filter that helps in clearing environment= $250

Outcome: Dexter needs to install filter.

3. (12 points) What are the differences between public and private goods? Give an example of each type of good.

Public Good	Private Good
These types of goods are paid through local, state and federal taxes.	The taxes on private goods are paid by individuals
These goods are required by all persons and are a necessity for everyone	These goods are required according to the income level. Not everyone can afford them
These are not intentionally paid for and these are provided by the government	The private goods are sold at a price that is determined by the forces of demand and supply.
Public Good is characterized by non-rivalry & non-excludability	A private good is characterized by Rivalry & Excludability
Examples: Waste and Trash collection	Examples: Cars, houses

4. (48 total points) Suppose you are hired by the Martin guitar company as an economic consultant. You estimate the demand for Martin guitars to be Q = 9,000 – 6P.

a) (6 points) Suppose the supply of Martin Guitars is given by Q = -3000 +9P. What is the

equilibrium price and quantity of Martin guitars?

Equilibrium price is where demand = supply

So we equate both the equation

9,000 – 6P = 3000 +9P

(9+6)P = 9000 +3000

15P=12000

P= 800

Equilibrium Price is 800, to find equilibrium quantity, we will substitute this in any equationand find Q

Q= 9,000 – 6P, P=800

Q= 9000 – 6 x 800 = 9000 – 4800 = 4200

Equilibrium price of Martin guitars = $800

Equilibrium quantity of Martin guitars = 4200

b) (6 points)What is the price elasticity of demand at the equilibrium price and quantity?

Price elasticity is given by formula = (P/Q) X (Change in Q / Change in P)

(Change in Q / Change in P) = slope of the demand curve = -6

Substituting the values in equation = 800/4200 x -6 = – 1. 14

c) (6 points) What is the price elasticity of supply at the equilibrium price and quantity?

Price elasticity of Supply = (P/Q) X (Change in Q / Change in P)

(Change in Q / Change in P) = slope of the Supply curve = 9

Substituting the values in equation = 800/4200 x 9 = – 1. 71

For the next three questions, suppose a per-unit excise tax of $90 per guitar is levied on the consumers.

d) (6 points) What price will consumers pay after the tax is levied?

When the tax is levied P = P +90

Demand Q= 9000 -6(P+90)= 9000 -6P -540 = 8460 -9P

Supply Q= -3000+9P

Equating both equations

8460 -6P = -3000+9P

15P =11460

P= 764

Q= -3000 + 9 X 764 = 3876

Price to be paid by consumers after tax is 764+ 90= 854

e) (6 points) What proportion of the tax will be paid by the suppliers of Martin guitars?

It is the consumers who pay the tax

Consumer price = 854, pre tax price was =800

Tax = 854-800=54

Consumers pay 54/90 x 100 = 60%

Suppliers pay 40% of tax or $36

f) (6 points) How many guitars will be sold after the tax is imposed?

Q= -3000 + 9 X 764 = 3876

g) (6 points) How much consumer surplus do consumers get after the tax?

there is a consumer deficit of 
(800-854)*3,876 = ($209,304)

h) (6 points) What is the deadweight loss created by this tax?

Producer Deficit = (764-800)*3,876 = ($139,536) 
PLUS: Consumer Deficit = ($209,304) 

Deadweight = $348,840

Society’s willingness to pay 100 80 60 40 20

Quantity of public good

society’s willingness to pay