Economics 101

Fall 2001

Answers to Practice Questions #10

Question 1: 

  1. negative consumption externality
  2. positive consumption externality
  3. positive consumption externality
  4. negative production externality
  5. positive production externality

Question 2:

  1. In order to find the market demand for a public good, we need to vertically add the individual demand curves, i.e. we need to add the people’s willingness to pay. Thus, the market demand curve is kinked and given by:
P = 150 – 4Q for Q <=22.5

P = 105 – 2Q for 22.5<=Q<=45

P = 60 – Q for Q>=45

Since MC = Q if you draw a graph, you can easily see that equilibrium occurs when the MC curve intersects the middle portion of the kinked market demand curve. Set this equal to MC to find the equilibrium quantity: 105 – 2Q = Q, thus, Q = 35. 

  1. The total price is given by the market demand curve: P = 105 – (2)(35) = $35.
  2. Now that we know that Q = 35 is the optimal amount to be provided, we can also fond how much each individual is willing to pay for this quantity: 
Bob: P = 60 – Q = $25

Ed: P = 45 – Q = $10

Note that Jane is not in the market for any quantity larger than 22.5 (you can draw Jane’s demand curve to see this).

The total amount these three agree to pay equals $25 + $10 = $35, which equals the price that we found in part B as well as the marginal cost of producing Q = 35.

  1. The optimal amount may not be provided. Since the park is a public good, none of the residents can be excluded from using it once it is build. Therefore, none of the residents have an incentive to reveal correct information about their willingness to pay for the park. Instead, they each hope that someone will pay for it and they can free ride.

Question 3: 

  1. Before the rights are issued, there is the issue of overfishing since no one owns the lakes.
  2. To find the equilibrium, set P = 250 – Q equal to MC = Q. This yields Q = 125 rights at a price of P = $125 each.
  3. Since we are talking about the market for ice fishing rights, this is a negative production externality. The issue (in a way, production) of the rights discourages ice fishing, it reduces the business for local merchants.
  4. To find the socially efficient outcome, set P = 250 – Q equal to MC = Q + (Q + 10), i.e. we are adding the external cost to the original marginal cost equation. This yields Q = 80 rights at a price of P = $170 each.

Question 4: 

E. All of the above.

Question 5: 

  1. (A), (B), and (C)

Question 6: 

C. good X is overproduced.