Economics Study Set 19

Business

Quiz 17 :
Natural Resource and Energy Economics

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Quiz 17 :
Natural Resource and Energy Economics

(a) Since there is an equal amount of good and used car in the market, with good cars being worth $13,000 and bad cars being worth $5,000, we see that the average value of a used car can simply be found by taking the probability that a car is a good car (0.5), multiplying that by the value of a new car, and adding to that the probability that a car is a bad car (0.5) multiplied by the value of a bad car. To put this into an equation, we have: img (b) Since the average value is $9,000, the average value exceeds the value of a bad used car is img Average value exceeds the value of a bad used car is $4000 Value of a good used car exceeds the average value by img Average value exceeds the value of good used car is $4000 (c) A potential seller of a good car probably will not be willing to sell his vehicle for $9,000. If his car was worth $13,000, since he knows that it is a good used car, it would not make sense to sell for $9,000. The whole point about asymmetric information is that the seller of a good car knows that his car is good, so he will not want to sell it for much lower than what it's worth, as he understands that his car is truly worth $13,000. (d) If a buyer was able to negotiate the price down to the average value price, it is probably the case that the car being negotiated upon is a bad used car. As we saw in part (c), a seller of a good used car will most likely not sell his car for $9,000. The fact that someone is willing to sell at $9,000 makes it likely that the seller knows his car is a bad car and thus only worth $5,000. Because of this, he is definitely willing to sell his car for $9,000. (e) The used car market will still have both good and bad cars, since the average price will not be the price in the market. In a way, consumers will know that if they are able to negotiate the price of a car down to a much lower price, then there is a good chance that the car they are buying is a lemon. Good cars will still be in the market because buyers actually want good cars, and may be willing to pay a bit more just to ensure that the car they are getting is not a bad one. As far as how much used cars will cost if all the good cars are withdrawn - the immediate impact is probably that the price of used cars will not change. Buyers do not know whether cars are good or bad, so if all the good cars were taken out, then it is likely that the price will be exactly the same as it was before the good cars were taken out. However, in the long run, prices will probably fall because every buyer will be getting a bad car, and thus the buyer side will get more information than they had before (information that the cars in the used car market are all bad).

Here, it is a problem of adverse selection for the insurance companies because they have less information about the buyers than the buyers have about themselves. Hence, it is more likely that they will make a bad choice (hence the term adverse selection) about who to insure, as it is likely that those who want to get a payout will be those who want to buy insurance. For example , someone who is sick is more likely to want insurance, because they want the payout that the insurance will give them. This means that insurance companies must increase the premium (or the money that is charged to have the insurance coverage every set period of time) that is charged on each consumer, because if the premium is set too low, the insurance companies might be taken advantage of. For example, if a company offers everyone a low premium, it is very likely that those who are at highest risk for needing a payout will want to buy this insurance. However, if the company offers a high premium, then some people may not be able to afford to have the insurance, even though they want to get the payout from it. The companies must also do this because they have less information than the buyers of the insurance. If the firms had perfect information, they would know exactly what rate to charge each person. However, since they do not have all the information they want, they need to increase the premium so that they protect themselves from losing money in offering insurance to the "wrong" people.

(a) On average, a $2 billion cost of having higher sugar prices will cost $6.67 for each of the 300 million people living in the United States. To see this, we simply take $2 billion ($2,000,000,000) and divide it by 300 million people (300,000,000) and we will get $6.67 per person. Turning to the $150 million subsidy, we see that this will cost an average of $0.50 per person living in the United States. Once again, we find this by taking the cost of $150 million ($150,000,000) and divide it by 300 million people. Therefore, the combined cost per person for these two things is $7.17. (b) On average, the $150 million per year in subsidies going to the 13,000 beet growers means that each beet grower, on average, will receive about $11,538.46 in subsidies. We find this by dividing $150 million by 13,000 beet growers. Turning now to the sugar cane growers, we see that the $150 million per year in subsidies going to 1500 cane growers means that each cane grower, on average, will receive $100,000 in subsidies. We find this by dividing $150 million by 1500 cane growers. (c) We see that 2000 beet farms receive about half the subsidies. This means that 200 beet farms receive $75 million of the subsidies. On average, this means that each of the 2000 beet farms will receive $37,500 of subsidies. img Turning now to the sugar cane producers, we are given that about 20 cane farms will receive half of the sugar cane subsidies, which is $75 million. Therefore, we see that on average, these 20 farms will get $3,750,000 in subsidies. img (d) Here, see that each person living in the United States has a cost of $7.17 from the increased prices of sugar and one of the largest 20 cane farms will on average receive $3,750,000 in subsidies per year. Therefore, we see that we need to mobilize about 523,013 people to oppose sugar subsidies in order for the combined losses of these people to exceed the money going to one of the 20 largest cane farms. We get this number by dividing $3,750,000 (the subsidy that one of the 20 largest cane farms receive) by $7.17 (the average cost per person in the U.S. from higher sugar prices). In other words, when we can get 523,013 consumers in the U.S. together, the sum loss of these people from higher sugar prices is just exceeding the subsidy that one of the 20 sugar cane farms receives each year.

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