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Instructor: Akos Lada
Harvard Kennedy School
Mid-Career MPA
Summer Program 2014
Problem Set #3: Welfare, Externalities and Public Goods
Due August 8th, 2014
1. Coffee, Welfare and Elasticity: Suppose the demand for packaged coffee is given by:
QD= 15-0.5P and the supply of packaged coffee is given by: QS=P
a. Plot the demand and supply curves on the same graph. Find the equilibrium
graphically and algebraically: what is the equilibrium price and quantity of coffee?
b. At this equilibrium, calculate consumer surplus (CS), producer surplus (PS), and
social surplus (SS).
c. Now assume coffee producers lobby the government to institute a price floor of $12.
What will be the new price and quantity of coffee transacted in the market? The new
CS, PS, and SS?
d. Who gains and who loses from the price floor? What is the DWL from the price
floor?
e. In one sentence ONLY, explain what DWL is in this specific case - what is actually
lost?
f. Calculate the elasticity of demand when the price increases from the equilibrium price
found in (a) to $12. Is it elastic or inelastic demand?
g.
2. Externalities in Gnomeland
a. In Gnomeland, externalities pervade in four markets (listed below). For each, state the
kind of externality that exists.
i.
A local seafood restaurant is incredibly popular with the town, and is
especially loved for its fried calamari. However, the restaurant’s surrounding
neighbors complain that whenever the chefs are cooking, they cannot rid their
homes of the unpleasant, fishy aroma.
ii. A parking lot, which offers parking space for up to 100 residents and visitors
of Gnomeland. However, during peak hours (9 AM and 5 PM) the sound of
honking, breaking, and traffic disturbs area gnomes.
iii. A vaccination for swine flu, which makes individuals immune against the
illness.
iv.
A florist, who provides wonderful bouquets and floral arrangements for many
Gnomeland festivities, has a beautiful garden where he grows all of his
flowers. Many gnomes enjoy passing the garden and admiring its beauty as
they walk through town.
b. Draw a well-labeled graph for each of the four markets described above. Be sure to
include and label S, D, MPB, MPC, MSB, MSC, Qmkt (the market quantity), Qeff (the
socially optimal quantity) and DWL.
c. In which markets would the government consider implementing a tax? Which might
they subsidize?
3. Public Goods: Suppose there are two people in a society – a hawk and a dove. The hawk
wants to spend lots of money on national defense systems (a public good), whereas the dove
is less keen on doing this. The demand curves for single “units” of national defense for the
two different individuals are given as follows:
Instructor: Akos Lada
Harvard Kennedy School
Mid-Career MPA
Summer Program 2014
The “hawk”: QD=500-10P
The “dove”: QD=100-10P
Suppose that the marginal cost (or the "price") of a unit of national defense is constant at $50.
a. Does any single individual have an incentive to buy a unit of national defense?
b. Draw the demand curve for national defense for all individuals in society (remember
what kind of good we have here...).
c. What is the socially optimal number of units of national defense?