Quiz 5: Governments Role and Government Failure

Business

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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Essay

Consumer surplus is the differences of the maximum prices consumers willing to pay and the lower market price. The table below shows the market data. The total consumer surplus is the sum of all individual consumer surpluses. The consumer surplus is negative because the new equilibrium price is too high to leave any surplus for consumers, while the highest willingness to pay stays unchanged.

Q 2

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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Essay

A market failure happens in a particular market when the market produces an equilibrium level of output that either over allocates or under allocates resources to the product being traded in the market. The two causes for market failure are demand-side market failures and supply-side market failures. Demand-side market failures happen when demand curves do not reflect consumers' full willingness to pay for a good or service. It means that it is impossible in certain cases to charge consumers what they are willing to pay. Consider fireworks displays. Private firms will be unwilling to produce outdoor fireworks displays, as it will be nearly impossible for them to raise enough revenue to cover production costs. Demand-side market failures cause underproduction of a certain good. Supply-side market failures occur when supply curves do not reflect the full cost of producing a good or service. It means that a firm does not have to pay the full cost of producing its output. Consider a coal-burning power plant. It procures more electricity and generates more pollution than it would if it had to pay for the pollution. The extra units that are produced are units of output for which the costs are greater than the benefits; hence the overproduction problem. Supply-side market failures cause overproduction of a certain good. When market failure occurs, it either means underproduction or overproduction; thus, it is impossible for a market be affected by both types simultaneously.

Q 3

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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Essay

Producer surplus is the differences between the actual price producers receive ($6) and the lower minimum payments they are willing to accept. The table below summarizes the market. The market total producer surplus is the sum of all individual producer surpluses.

Q 4

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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Q 5

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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Q 6

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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Q 7

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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Q 8

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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Q 9

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.

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Q 10

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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Q 11

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.

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Q 12

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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Q 13

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?

Essay

Q 14

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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Q 15

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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Q 16

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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Q 17

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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Q 18

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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Q 19

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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Q 20

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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