Macroeconomics Study Set 63

Business

Quiz 5 :

Governments Role and Government Failure

Quiz 5 :

Governments Role and Government Failure

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Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these two sets of ideas?
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Competitive markets are efficient because the equilibrium reflect productive efficiency and allocative efficiency.
Productive efficiency is achieved because competition forces producers to use the best technologies and combinations of resources to minimize costs.
Allocative efficiency is achieved because the correct quantity of production in produced relative to other goods and services.
The way to see why the equilibrium quantity is the correct quantity is based on analysis of consumer and producer surplus. Only at the equilibrium quantity does society achieve the maximum of total consumer surplus ( abc ) and producer surplus ( bcd ). Geometrically, producing the equilibrium quantity maximizes the combined area between demand curve and supply curve abd.
img Quantities ( Q ' ) below the equilibrium quantity ( Q* ) are inefficient. The market suffers and underproduction and is illustrated in the graph below. The maximum willingness to pay on the demand curve up to the equilibrium quantity exceeds the corresponding minimum acceptable price on the supply curve. Thus, each of these units of production adds a positive amount to the total of consumer and producer surplus. By failing to produce these units society suffers a loss of net benefits ( bef ).
img Quantities ( Q ' ) beyond the equilibrium quantity ( Q* ) are inefficient. The market suffers an overproduction and is illustrated in the graph below. The maximum willingness to pay on the demand curve beyond the equilibrium quantity is less than the corresponding minimum acceptable price on the supply curve. Thus, each of these units of production adds a negative amount to the total of consumer and producer surplus. Such production is uneconomical and creates an efficiency loss for society ( bef ).
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Explain why zoning laws, which allow certain land uses only in specific locations, might be justified in dealing with a problem of negative externalities. Explain why in areas where buildings sit close together tax breaks to property owners for installing extra fire prevention equipment might be justified in view of positive externalities. Explain why excise taxes on beer might be justified in dealing with a problem of external costs.
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Zoning laws is justified because it eliminates over-use of certain lands. Plants that emit pollution are supposed to be located downstream and far from farms so that the pollution will not pollute water and crops. Without the zoning law, plants will not take pollution in account and tend to use lands regardless of their location. External costs can be prevented by the zoning law. Zoning law eliminates the potential impropriate use of certain lands.
Fire prevention equipment provides external benefit to neighbors. The household that install the equipment not only benefit himself from reducing risk of fair, but also provides safety for neighbors. With tax breaks government is making subsidy to household who installs the equipment. The tax breaks make the price of equipment cheaper and increase the demand. As a result, the equilibrium quantity increases to the optimal level.
Consumption of beer has potential negative externalities such as higher risk of traffic accidents, less efficiency on job, higher risk of crime, etc. The excise taxes on beer raises the price and reduces demand. As a result, the equilibrium quantity demanded decreases to the optimal level.

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What are the two characteristics of public goods? Explain the significance of each for public provision as opposed to private provision. What is the free-rider problem as it relates to public goods? Is U.S. border patrol a public good or a private good? Why? How about satellite TV? Explain.
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The two characteristics of public goods are non-rivalry and non-excludability.
Non-rivalry means that the consumption of the good by one consumer does not decrease the availability of the good to other consumers. Consider the street lights. One consumer's use of street lights does not decrease others' use.
Non-excludability means that it is impossible to withhold any consumers who do not pay for a product from consuming the good. Consider national defense. It is impossible to exclude someone from the benefit of national defense.
When private provision happens the good is rivalry and excludable. When Adams purchases and drinks a bottle of water, it is not available for Benson to purchase and consume. Thus, the significance of rivalry is much higher for private provision than for public provision. Only people who are willing and able to pay the market price for bottles of water can obtain these drinks; thus, the significance of excludability is much higher for private provision than for public provision.
Free rider problem means that once a producer has provided a public good, everyone, including non-payers, can obtain the benefit. Non-excludability means that there is no way for producers to withhold the good from the free riders without also denying it to the few who do pay. Thus, if society wants public good it will have to direct government to produce it.
U.S. border control is a public good, because it is non-rivalry and non-excludable. One person's safety brought by the border control does not decrease the safety available to others; it is impossible to withhold someone in the U.S. from obtaining the benefit of U.S. border control.
Satellite TV is a quasi-public good. It is non-rivalry - one consumer's consumption does not affect the availability of Satellite TV to others. It is excludable - by charging a price, providers of satellite TV can exclude consumers who is not willing to pay the price.

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ADVANCED ANALYSIS Assume the following values for Figures 5.4a and 5.4b. Q 1 = 20 bags. Q 2 = 15 bags. Q 3 = 27 bags. The market equilibrium price is $45 per bag. The price at a is $85 per bag. The price at c is $5 per bag. The price at f is $59 per bag. The price at g is $31 per bag. Apply the formula for the area of a triangle (Area = ½ x Base x Height) to answer the following questions. a. What is the dollar value of the total surplus (producer surplus plus consumer surplus) when the allocatively efficient output level is being produced? How large is the dollar value of the consumer surplus at that output level? b. What is the dollar value of the deadweight loss when output level Q 2 is being produced? What is the total surplus when output level Q 2 is being produced? c. What is the dollar value of the deadweight loss when output level Q 3 is produced? What is the dollar value of the total surplus when output level Q 3 is produced?
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Draw a supply and demand graph and identify the areas of consumer surplus and producer surplus. Given the demand curve, what impact will an increase in supply have on the amount of consumer surplus shown in your diagram? Explain why.
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LAST WORD Distinguish between a carbon-tax and a cap-and-trade strategy for reducing carbon dioxide and other so-called greenhouse gases (that are believed by many scientists to be causing global warming). Which of the two strategies do you think would have the most political support in an election in your home state? Explain your thinking.
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Refer to Table 5.2. If the six people listed in the table are the only producers in the market and the equilibrium price is $6 (not the $8 shown), how much producer surplus will the market generate?
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Look at Tables 5.1 and 5.2 together. What is the total surplus if Bob buys a unit from Carlos? If Barb buys a unit from Courtney? If Bob buys a unit from Chad? If you match up pairs of buyers and sellers so as to maximize the total surplus of all transactions, what is the largest total surplus that can be achieved?
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On the basis of the three individual demand schedules below, and assuming these three people are the only ones in the society, determine (a) the market demand schedule on the assumption that the good is a private good and (b) the collective demand schedule on the assumption that the good is a public good. img
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Why are spillover costs and spillover benefits also called negative and positive externalities? Show graphically how a tax can correct for a negative externality and how a subsidy to producers can correct for a positive externality. How does a subsidy to consumers differ from a subsidy to producers in correcting for a positive externality?
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Explain the following statement, using the MB curve in Figure 5.9 to illustrate: "The optimal amount of pollution abatement for some substances, say, dirty water from storm drains, is very low; the optimal amount of abatement for other substances, say, cyanide poison, is close to 100 percent."
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The Lojack car recovery system allows the police to track stolen cars. As a result, they not only recover 90% of Lojack-equipped cars that are stolen but also arrest many auto thieves and shut down many "chop shops" that take apart stolen vehicles to get at their used parts. Thus, Lojack provides both private benefits and positive externalities. Should the government consider subsidizing Lojack purchases?
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Use your demand schedule for a public good, determined in problem 5, and the following supply schedule to ascertain the optimal quantity of this public good. img
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Refer to Table 5.1. If the six people listed in the table are the only consumers in the market and the equilibrium price is $11 (not the $8 shown), how much consumer surplus will the market generate?
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Explain the two causes of market failures. Given their definitions, could a market be affected by both types of market failures simultaneously?
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Look at Tables 5.1 and 5.2, which show, respectively, the willingness to pay and willingness to accept of buyers and seller of bags of oranges. For the following questions, assume that the equilibrium price and quantity will depend on the indicated changes in supply and demand. Assume that the only market participants are those listed by name in the two tables. a. What is the equilibrium price and quantity for the data displayed in the two tables? b. What if instead of bags of oranges, the data in the two tables dealt with a public good like fireworks displays. If all the buyers free ride, what will be the quantity supplied by private sellers? c. Assume that we are back to talking about bags of oranges (a private good), but that the government has decided that tossed orange peels impose a negative externality on the public that must be rectified by imposing a $2-per-bag tax on sellers. What is the new equilibrium price and quantity? If the new equilibrium quantity is the optimal quantity, by how many bags were oranges being overproduced before?
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Draw a production possibilities curve with public goods on the vertical axis and private goods on the horizontal axis. Assuming the economy is initially operating on the curve, indicate how the production of public goods might be increased. How might the output of public goods be increased if the economy is initially operating at a point inside the curve?
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Use the distinction between the characteristics of private and public goods to determine whether the following should be produced through the market system or provided by government: (a) French fries, (b) airport screening, (c) court systems, (d) mail delivery, and (e) medical care. State why you answered as you did in each case.
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What divergences arise between equilibrium output and efficient output when (a) negative externalities and (b) positive externalities are present? How might government correct these divergences? Cite an example (other than the text examples) of an external cost and an external benefit.
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An apple grower's orchard provides nectar to a neighbor's bees, while the beekeeper's bees help the apple grower by pollinating his apple blossoms. Use Figure 5.6b to explain why this situation of dual positive externalities might lead to an underallocation of resources to both apple growing and beekeeping. How might this underallocation get resolved via the means suggested by the Coase theorem?
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