Download 1. Public Goods

Department of Economics, CSUS
Economics 1B
Fall 2002
Name:____________________
Section Number:____________
Problem Set 5 Solutions
Due Thursday, December 5th, at the beginning of lecture
Write all answers neatly on the pages given. Draw all graphs in the space provided and write descriptions under the
questions. Show all of your work. You may discuss questions you have with other students, but your answers need
to be in your own words. Answers that appear to be copied from another student will receive a grade of zero.
1. Public Goods
A three person city is considering adding a tire swing to their playground. Joey is willing to
pay $100 for the swing. Ross is willing to pay $20 for the swing, and Chandler is willing to
pay $50 for the swing. The swing costs $150.
a. Will any single person buy the swing on his own?
No. The swing costs $150, and the most anyone is willing to pay is $100.
b. If the cost of the swing is divided equally among the citizens, would a majority vote in
favor of building the swing?
Chandler & Joey would vote for the swing, but Ross would not. A majority would vote in favor
of building the swing.
c. Why does the government often need to step in for society to obtain an efficient level of
public goods?
The government needs to step in to provide public goods, because in the absence of government
intervention, individuals would not provide them. Groups of individuals may have an incentive
to provide a public good, but there is a free rider problem, where potential beneficiaries of the
public good would not want to pay for it, since once it was produced, everyone could enjoy the
good. The government has the ability to tax in order to provide sufficient levels of public goods
and have everyone contribute to pay for the good.
2. Health Care
a. Draw a graph representing the supply and demand for Alegra allergy medication.
Assume demand is downward sloping and supply is upward sloping. Label the
equilibrium price and quantity that would exist in a competitive market.
P
S
Pso
$5
D
Qso
Qi
Q
Department of Economics, CSUS
Economics 1B
Fall 2002
Name:____________________
Section Number:____________
b. We recognize that consumers of Alegra usually have prescription drug insurance, so that
they only have to pay a co-payment each time they have their prescriptions filled.
Assume the co-payment is $5 each time they fill their prescriptions, and that this is less
than the market price. Label the quantity consumers would purchase at this low price on
your graph. (This is almost like a price ceiling, except now, consumers actually get to
buy as much as they demand at this low price.)
The quantity demanded at the $5 co-payment is Qi on the graph above.
c. Is this quantity socially optimal? Explain the relationship between the cost of the drug
and the value of the drug to the marginal consumer.
Qi is not socially optimal because the marginal cost of providing the last unit (on the supply
curve) is much greater than the value of the drug to the marginal consumer (on the demand
curve). Because consumers don’t have to pay the true cost of the drug in order to consume the
marginal unit, more than the socially optimal quantity is consumed. The cost of providing units
above Qso is greater than the value of the units to the consumers. Anytime the marginal benefit
is less than the marginal cost, society should produce fewer units to achieve a socially optimal
outcome.
3. Environment
a. Air pollution is a negative production externality. Draw a graph of this externality using
marginal social cost, marginal private cost, marginal social benefit, and marginal private
benefit curves. Label the market equilibrium and the socially optimal level of output.
How could society obtain the socially optimal level of output?
P
MSC
MPC
Pso
Pc
MPB=MSB
Qso Qc
Energy Production
Society could obtain the socially optimal level of output by taxing producers by the amount of
the externality, making them internalize the externality. The government could also issue
pollution permits to reduce pollution.