EC102: Class 10 Christina Ammon

Notes on the Problem Set Two grades: One for multiple choice and one for Essay questions – put most of the weight on essay for final grade For exam: would have all been saved by multiple choice In Exam: 40% multiple choice, 30% essay micro, 30% essay macro Feedback: Have been given points for each subquestion (max 5) Even though format similar to mock exam, there was no exam style marking scheme, so grades will vary across teachers If you have any questions: come to my office hour today 13:30-14:30 Can give you more detailed feedback

Question 7h) Use the model of monopolistic competition to discuss what happens to domestic firms when foreign firms start selling in the domestic market. Two effects of opening to international trade demand curve can become flatter Or damand curve can shift inwards some firms get displaced

Externalities When the activity of one entity/agent directly affects the welfare of another in a way that is not captured in prices Two results Social costs ≠ private costs Social benefits ≠ private benefits Missing markets If there are externalities  Welfare Theorems no longer hold

Question 1 The London tube is one of the busiest undergrounds in the world. Whenever a commuter takes the tube during rush hours, the congestion increases. During rush hours an externality is present because: The tube is a monopoly The tube is not properly managed There is a missing market

Question 2 S is supply, D is demand, SMC is social marginal cost, PMC is private marginal cost, MD is marginal damage. At the level of steel output X0 there is: Too much pollution because SMC is below D Too little pollution because SMC is above PMC Too much pollution because SMC is above MD Too little pollution because SMC is below D

The Coarse Theorem the efficient solution will be achieved through private bargaining independently of who is assigned the ownership rights, as long as someone is assigned those rights Limits: Cannot identify sources of damage/agents that suffer Asymmetric information Bargaining costs

Question 3 S is supply, MR is marginal revenue, SMC is social marginal cost, PMC is private marginal cost, MD is marginal damage. If the steel mill is price taker and the ownership of clean air is assigned to the forestry firm, the largest bribe the steel mill would be willing to pay for permission to produce more than X* is: More than enough to convince the forestry firm to give permission Just enough to convince the forestry firm to give permission Not enough to convince the forestry firm to give permission

Question 3

Question 4 From time to time, used hospital waste, such as hypodermic needles from unknown hospitals, wash up on beaches. This creates an externality imposed on the public by the hospitals in terms of dirty water and unsafe beaches. In this case the Coase Theorem: Would lead to the correction of the implied externality Would not lead to the correction of the implied externality

Question 6 “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” (Adam Smith)

Question What is the consequence of that statement? Does this still hold if we have externalities? What about if the Coarse Theorem doesn’t hold Real life examples of externalities: Pollution Why does the Coarse Theorem not work here? Missing markets – how can the government intervene?

Correcting for Externalities What is a Piguvian Tax? A corrective tax that alignes the private marginal cost with the social marginal cost Other ways to intervene: Regulation/legal interventions Creating a market/effluent fee What would be the optimal strategy in the case of pollution?

Question 5 If each pack of cigarettes smoked creates 68 pence of externalities borne by other members of society (in terms of the costs of cigarette smokers’ excess use of health services, of foetal death, and of second-hand smoke), the situation can be corrected by a Pigouvian of: 68 pence 32 pence 34 pence 16 pence