Homework Chapter 3

The demand for the Tesla electric automobile is P = 200,000 – 2 Q, where P is in $/car and Q is the number of cars sold per year. Currently, the U.S. government offers incentives to buyers of electric vehicles worth $5000. If the current selling price of the Tesla is $75,000, what is consumer surplus when the subsidy is available? What will be the change in consumer surplus after the incentive has expired? $ ∆𝐶𝑆=$ 75−70 𝐾∗62.5𝐾+0.5 ∗$ 75−70 𝐾 ∗(65−62.5𝐾) = Loss of $318,750,000 200,000 CS = 0.5$(200-70)K*(65K) 75,000 CS = $4,225,000,000 70,000 D CS = 0.5$(200-75)K*(62.5K) 62,500 65,000 100,000 Q CS = $3,906,250,000

2. The supply of the Tesla in question 3 is P = 20,000 + 10 Q, P is in $/car and Q is the number of cars produced per year. If the current selling price of the Tesla is $75,000, what is producer surplus (there is no subsidy available)? $ S PS = 0. 5*(75-20)K*(5.5K) = 1,351,250,000 75K PS 50K 20K 5.5K Q

3. Using the information in questions 1. and 2 3. Using the information in questions 1. and 2., find the equilibrium price and quantity of the car assuming there are no buyer subsidies. Also find consumer and producer surplus and total social welfare. $/Q S $200K CS = 0.5$(200-170)K*(15K) = $225,000,000 CS CS $170K PS = 0.5$(170-20)K*(15K) = $1,125,000,000 PS PS SW = CS + PS = $1,345,000,000 D $20K 100K 15K Q

4. Chinese electric car manufacturer LeEco has invested $300 million in its plant. They expect the plant to last 10 years, and have annualized the capital cost to $30,000,000 per year. Their operating costs are $20,000 per car. They expect to sell 1000 cars per year at $30,000 per car. What do you recommend they do in the short run? In the long run? SR: MC = $20,000. P > MC, so operate. LR: Contribution to 𝜋=𝑇𝑅 −𝑇𝐶 =$30,000∗1000 −$20,000∗1000=$10,000,000 Not covering capital cost. Try to sell the plant.

5. In the short run, LeEco’s plant investment in question 4: a. Is a variable cost and should be included when calculating the opportunity cost of producing the car b. Is a variable cost and should not be included when calculating the opportunity cost of producing the car c. Is a fixed cost and should be included when calculating the opportunity cost of producing the car d. Is a fixed cost and should not be included when calculating the opportunity cost of producing the car d. Is a fixed cost and should not be included when calculating the opportunity cost of producing the car

6. Some people believe that high-voltage power lines create electromagnetic fields (EMFs) that may increase the likelihood of cancer for people living near those lines. What would Pigou recommend we do? What about Coase? Pigou would recommend taxing the owners of the high-voltage power lines Coase would recommend clearly defining property rights. If the transmission line owners have the right, then people living near the lines would have to compensate transmission line owners to reduce EMFs. If nearby residents own the rights, then the owner of the transmission line would have to compensate nearby residents to accept EMGs.

$/Q $35 7. Arthur’s demand to reduce EMFs is P = 20 – 2 Q, while Ronald’s demand is P = 15 – 3 Q. If the marginal cost of reducing emissions is equal to $15 and is constant, what is the optimal amount of EMG reduction? $20 DT = 35 – 5*Q $15 MC $10 MB = MC 35 – 5*Q = 15 DR = 15 – 3Q DA = 20 – 2 Q Q = 4 4 5 10 Q

$/Q $35 8. Referring to question 7., what Lindahl prices would you charge Arthur and Ronald? What might prevent you from collecting these prices? $20 DT = 35 – 5*Q tA=12 $15 MC tR=3 tA=12 $10 Individuals may free ride, since they can get benefits and cannot be excluded. DR = 15 – 3Q DA = 20 – 2 Q tR=3 4 5 10 Q

9. The most common way to evaluate social welfare is through cost-benefit analysis. What is the underlying equity assumption? Why is it controversial? Why do we use it anyway? $=$ Ignores MU poor > MU rich. Difficult to decide how much we should weight poor vs. rich.

10. Which one of the following is a pure public good? a. A Tesla automobile b. A weather report made available to electric utilities that pay for a subscription. c. Traffic congestion d. The lighting in a classroom