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Econ problem set – Externalities

1.     For each of the goods listed below, discuss whether the good is likely to entail an external cost or an external benefit. Additionally, explain if the market is likely to produce more or less than the social optimal. a.     Vaccinations b.     Cigarettes c.     Antibiotics d.     Sriracha sauce   2.     Using the information from Slide 10 in the externalities lecture, assume the rent for an individual apartment is $550. a.     Will Jonathan and Mark be able to negotiate a solution to their shared rent or will they each live separately? b.     What is the maximum amount Mark would be willing to pay to keep Jonathan as his roommate? c.      Which option is the most fair – splitting the rent evenly or splitting the surplus evenly? d.     Which outcome is most likely to occur in real life? Why?     3.      A village has six residents, each of whom has accumulated savings of $100. Each villager can use this money either to buy a government bond that pays 15% per year or buy a llama, send it onto the commons to graze and then sell it after one year. The price the villager gets for selling the llama depends on quality of fleece it grows. The quality of fleece depends on how many llamas are grazing.            Number of Llamas          Price per Llama          1          122          2          118          3          116          4          114          5          112          6          109   a.     If each villager decides individually how to invest, how many llamas will be sent onto the commons and what will be the net village income? b.     What is the socially optimal number of llamas for this village? c.      The village committee votes to auction the right to graze the llamas to the highest bidder. How much will the grazing right sell for? What will be the net village income afterwards?   4.     Suppose the supply curve of portable radio rentals in Golden Gate Park is given  by      P= 5+ 0.1Q and the demand curve is by P = 20 – 0.2Q. a.     If each portable radio imposes $3 per day in noise costs on others, by how much will the market equilibrium quantity exceed the socially optimal number of rentals? b.     How would the imposition of a $3 per unit tax affect the efficiency in this market?              Chapter 11: Asymmetric Information   1.     State whether the following are true or false and briefly explain why a.     Companies spend billions of dollars advertising their products on network TV primarily because the texts of their advertisements persuade customers that the advertised products are of high quality. b.     You may not get the optimal level of advice from a retail shop when you go in to buy a lamp for your bike because of the free-rider problem. c.     If you need a lawyer, and all your legal expenses are covered by insurance, you should always choose the best-dressed lawyer with the most expensive car and the most ostentatiously furnished office d.     The benefit of searching for a spouse is affected by the size of the community you live in.   Consumers know that some fraction of all new cars produced and sold in the market are defective. The defective ones cannot be identified except by those who own them. Assume that cars do not depreciate in value with use. Suppose consumers are risk-neutral and value non-defective cars at $10,000 each and defective cars at $6,000 each. If consumers are willing to pay $8,000 for a new car, what percentage of new cars are defective? If you saw a used car for sale with a price tag of $6,500, would you purchase this car? How many used cars for sale in this market will be good cars?   3.     Should consumers pay the premium to ensure high quality, or pay the minimum price and get the minimum quality?   4.     Ann and Barbara are computer programmers in Nashville who are planning to move to Seattle. Each owns a house that has been appraised for $100,000. Ann’s house is one of hundreds of highly similar houses in a large well-known suburban development, and Barbara’s is a one of a kind house built from her architects design.  Who will benefit more by hiring a realtor to assist in selling her house?

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