The graph below shows the car alarms market in which there is some kind of externality. SMB in figure stands for social marginal benefit.



Econ 107: Principles of Microeconomics       Spring 2020

Homework 2

Topic: Externalities and Public Goods (Ch 5)


Q1 [36 pts]: Externalities and Solutions (that can work and not)

The graph below shows the car alarms market in which there is some kind of externality. SMB in figure stands for social marginal benefit. [Replicas of the figure  are provided for your convenience on the last page if you want to work on separate graphs]

A picture containing sitting, boat, table, photo

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a.       (5 pts) What kind of externality is present in the car alarm market according to the figure; negative or positive? Briefly explain and give an example of such an externality that can be associated with car alarms.





b.      (6 pts) Determine the socially efficient output level. What is the maximum level of total welfare attainable in this market? Shade the area (or equivalently, use the letters provided to state the area).




c.       (6 pts) Determine the output of the free market. What is the level of total welfare associated with the free market equilibrium? Shade the area.




d.      (2 pts) What is the DWL that arises at the free market equilibrium in this market? Shade the area.



e.       (5 pts) Why do economists use the word external to describe third-party effects that are harmful or beneficial?





f.       (6 pts) Suppose a per unit subsidy is given to producers. What is the amount of per unit subsidy that can attain the maximum total welfare in this market? Show the effects of this subsidy on the graph and explain.




g.       (6 pts) Suppose that as an alternative government decides to provide the good itself and offers the good to the public at the price of zero. Whatever is demanded at zero price is provided. What would be the outcome of this policy? Would it achieve maximum social welfare or not? If you are answering no, then you have to prove your result by showing the welfare loss by shading the relevant area (or state the area).[1]

In doing so assume that government’s production costs are no different than that of private producers: This will ensure that the production costs depicted by the supply curve is still relevant. And no private firm provides the good.






Q2 [14 pts]: Pure Public Goods and the Free Rider Problem

Chickenpox and polio; once debilitating and deadly diseases, are not a big threat due to widespread immunization today. While immunization prevents children from getting sick with diseases that they are immunized for, in recent years some parents started to become concerned about the potential long-term effects of these immunizations and decided not to immunize their children.

a.       (7 pts) Explain how the decision by parents to not immunize their children, hoping that their children will not get sick because other parents have had their children immunized, is an example of free riding.




b.      (7 pts) Free riding is a problem that we experience with pure public goods. Seems like public health; especially when you have contagious diseases, have a public good nature. Explain this by referring the properties of pure public goods.

[1] Today, our government is providing the face masks for free; and I believe this policy is efficient. In the question you are working on free provision of the good is not efficient (Ups, I have given away a hint here, silly me). It might be fun to try and draw a figure where free provision really helps. Only if you want, not as a part of homework.

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