EC 101.

01&05 Problem Session: Chapter 9 Fall 2021

Solutions

1. Suppose demand is QD = 16 - P supply is QS = P. There is a constant positive externality of $4

per unit (Marginal External Benefit, MEB = $4). Find the maximum possible social surplus.

Answer: Marginal private benefit is MPB = 16 - Q, thus marginal social benefit is this marginal
private benefit plus the external benefit: MSB = MPB + MEB = 16 - Q + 4 = 20 - Q. This
intersects the marginal cost (both private and social as there are no negative externalities) at Q =
10. The maximum surplus is thus the area of the triangle below MSB and above MSC, which is
(1/2)*($20)*(10) = $100.

2. China’s economic growth has been powered by an increasing, coal-dominated fossil fuel
consumption. The coal production required to match such demand generates both carbon dioxide
and all particulate matters, along with arsenic, mercury, chromium and cadmium. This has
resulted in extremely high emission levels of carbon dioxide and all particulate matters. The
number of annual premature deaths attributable to this pollution is also high in China. Draw a
diagram and explain your answers to the following questions:

a. Will these high social costs imply a higher or a lower efficient quantity of coal?

b. If the Chinese government imposes taxes on air pollution, will the high social costs imply
a high or low level of tax required, to lead to the efficient level of coal production?

Answers:

a. This is an example of negative externality. The estimated damages from the coal
production have increased, as the annual premature deaths attributable to these gases
remain at high levels. The difference between the marginal cost of fuel consumption and

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 the supply of coal must have increased. In the graph below, marginal social costs shift up
from MSC1 to MSC2, which means that the efficient quantity of steel falls from Q1 to
Q2.

b. If the government imposes a tax on coal equal to the external damage of the coal
production, this means that increases from AB to CE.

See: “Air Pollution Control Policies in China: A Retrospective and Prospects”, International
Journal of Environmental Research and Public Health, 2016 Dec; 13(12): 1219,
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5201360/

3. There is a road between the suburbs and downtown. The road is congested at rush hour. If 100
people use the road at rush hour, the trip takes 30 minutes. If the 101st person enters the road,
everyone has to slow down and the trip now takes 31 minutes. People value their time at $6 per
hour (i.e., $0.10 per minute). For simplicity, ignore all of the costs of using the road other than
the cost of time.

a. What is the total social cost of 100 people using the road at rush hour?

b. What is the marginal social cost of the 101st person?

c. The governor of this state (who has taken a Principles of Economics course) would like
to institute a toll that would equal the costs the last driver who uses the road imposes on
the other drivers. How high should the toll be on this road during rush hour?

d. Suppose at noon 50 people are using the road. The road is not congested and the trip
takes just 20 minutes. If the 51st driver enters uses the road, no one has to slow down and
the trip continues to take 20 minutes. How high should the toll be at noon?

Answer:

a. The total social cost of 100 drivers is 100 drivers x 30 minutes per driver x $0.10 per
minute = $300.

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 b. The total social cost of 101 drivers is 101 drivers x 31 minutes per driver x $.10 per
minute = $313.10. The marginal social cost is the increase in total cost and therefore
equals $313.10 - $300.00 = $13.10.

c. The 101st driver makes the commute one minute longer for each of the other 100 drivers.
He therefore imposes a cost of 100 drivers x 1 minute per driver x $.10 per minute =
$10.00. The rush-hour toll should therefore equal $10.00. Each driver would “pay” 31
minutes per driver x $.10 per minute = $3.10 and the $10.00 toll, for a total of $13.10.
And for efficiency that is exactly what we (and the governor) want: the price of using the
road will equal the marginal social cost of using the road.

d. At noon, the last driver does not impose additional costs on other drivers because the road
is not congested. The toll should therefore be zero at noon.

4. Each year, a university organizes a students’ laser show at the beginning of the summer. Ana
and Jenna are willing to pay $40 to participate, Tom and Gerard are willing to pay $50, and
Laura and Sam are willing to pay $70. The cost of this laser show is $300.

a. In terms of efficiency, should the university organize the laser show?

b. Explain whether the students decide to organize the laser show on their own.

c. Suppose the students decide to put the matter to vote. If at least 4 of them vote in favor of
the laser show, each student will be taxed $60 and the laser show will be organized. How
many students will vote in favor?

Answer:

a. Yes. The total benefit is $320, while the costs are $300.

b. No. The maximum a pair of students can pay is $140 in case of Laura and Sam, which is
less than the cost of $300, so no one is willing to fund the laser show on their own.

c. Students will vote only if their private benefit is at least $60, so Ana and Jenna will not
vote. The other four will vote in favor of it.

5. The European Union has banned certain pesticides for two years after studies found links
between the use of these insecticides and a decline in the bee population. In particular, research
has shown that the use of imidacloprid, clothianidin, and thiamethoxam on flowering crops have
adversely affected the honeybee population in North America and Europe.
a. Consider the private market for these pesticides. Use supply and demand curves to show
the equilibrium level of pesticides that will be produced and consumed.

b. How might the impact of the insecticide on honeybees be modeled as a marginal external
cost? Show the deadweight loss from this externality in the graph you drew for the first
part of this question.

c. Is the private market outcome socially efficient?

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Answers:

a. The equilibrium quantity in the market is Q1.

b. At each level of production, the private cost of producing the pesticide plus the external
cost of the effect of the pesticide on bees equals marginal social cost (MSC). The MSC
curve includes both the private marginal cost and the external marginal cost. The efficient
quantity is the quantity where MSC intersects demand, Q2. The deadweight loss is the
shaded area in the diagram below. It is equal to the difference between demand and MSC
between Q1 and Q2.

c. The equilibrium quantity Q1 is greater than the efficient quantity Q2.