Figure 5-2
10. a. As Figure 5-2 shows, in both markets, the increase in supply reduces the equilibrium price and increases the equilibrium quantity.
b. In the market for pharmaceutical drugs, with inelastic demand, the increase in supply leads to a relatively large decline in the price and not much of an increase in quantity.
Figure 5-2
c. In the market for computers, with elastic demand, the increase in supply leads to a relatively large increase in quantity and not much of a decline in price.
1. If the price ceiling of $40 per ticket is below the equilibrium price, then quantity demanded exceeds quantity supplied, so there’s a shortage of tickets. The policy decreases the number of people who attend classical music concerts, since supply is lower because of the lower price.
2. a. The imposition of a binding price floor in the cheese market is shown in Figure 6-3. In the absence of the price floor, the price would be P1 and the quantity would be Q1. With the floor set at Pf, which is greater than P1, the quantity demanded is Q2, while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 - Q2.
b. The farmers’ complaint that their total revenue has declined is correct if demand is elastic. With elastic demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline.
c. If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose. Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially. But consumers would buy only quantity Q2 of cheese, so they are in the same position as before. Taxpayers lose because they would be financing the purchase of the surplus cheese through higher taxes.
Figure 6-3
8. a. Figure 6-8 shows the effects of the minimum wage. In the absence of the minimum wage, the market wage would be w1 and Q1 workers would be employed. With the minimum wage (wm) imposed above w1, the market wage is wm, the number of employed workers is Q2, and the number of workers who are unemployed is Q3 - Q2. Total wage payments to workers are shown as the area of rectangle ABCD, which equals wm times Q2.
b. An increase in the minimum wage would decrease employment. The size of the effect on employment depends only on the elasticity of demand. The elasticity of supply doesn’t matter, because there’s a surplus of labor.
c. The increase in the minimum wage would increase unemployment. The size of the rise in unemployment depends on both the elasticities of supply and demand. The elasticity of demand determines the quantity of labor demanded, the elasticity of supply determines the quantity of labor supplied, and the difference between the quantity supplied and demanded of labor is the amount of unemployment.
d. If the demand for unskilled labor were inelastic, the rise in the minimum wage would increase total wage payments to unskilled labor. With inelastic demand, the percentage decline in employment would be less than the percentage increase in the wage, so total wage payments increase. However, if the demand for unskilled labor were elastic, total wage payments would decline, since then the percentage decline in employment would exceed the percentage increase in the wage.
Figure 6-8
Figure 10-2
2. a. Fire extinguishers exhibit positive externalities in consumption because even though people buy them for their own use, they prevent fire from damaging the property of others.
b. Figure 10-2 illustrates the positive externality from fire extinguishers. Notice that the social value curve is above the demand curve.
c. The market equilibrium level is denoted Qmarket and the efficient level of output is denoted Qoptimum. The quantities differ because in deciding to buy fire extinguishers, people don't account for the benefits they provide to other people.
d. A government policy that would result in the efficient outcome would be to subsidize people $10 for every fire extinguisher they buy. This would shift the demand curve up to the social value curve, and market quantity would increase to the optimum quantity.
4. a. The externality is noise pollution. Ringo’s consumption of rock and roll music affects Luciano, but Ringo doesn’t take that into account in deciding how loud he plays his music.
b. The landlord could impose a rule that music couldn’t be played above a certain decibel level. This could be inefficient because there would be no harm done by Ringo playing his music loud if Luciano isn’t home.
c. Ringo and Luciano could negotiate an agreement that might, for example, allow Ringo to play his music loud at certain times of the day. They might not be able to reach an agreement if the transactions costs are high or if bargaining fails because each holds out for a better deal.
7. a. It's efficient to have different amounts of pollution reduction at different firms because the costs of reducing pollution differ across firms. If they were all made to reduce pollution by the same amount, the costs would be low at some firms and prohibitive at others, imposing a greater burden overall.
b. Command-and-control approaches that rely on uniform pollution reduction among firms give the firms no incentive to reduce pollution beyond the mandated amount. Instead, every firm will reduce pollution by just the amount required and no more.
c. Pigovian taxes or tradable pollution rights give firms greater incentives to reduce pollution. Firms are rewarded by paying lower taxes or spending less on permits if they find methods to reduce pollution, so they have the incentive to engage in research on pollution control. The government doesn't have to figure out which firms can reduce pollution the most¾ it lets the market give firms the incentive to reduce pollution on their own.
2. a. (1) Police protection is a natural monopoly, since it is excludable (the police may ignore some neighborhoods) and not rival (unless the police force is overworked, they're available whenever a crime arises). You could make an argument that police protection is rival, if the police are too busy to respond to all crimes, so that one person's use of the police reduces the amount available for others; in that case, police protection is a private good.
(2) Snow plowing is most likely a common resource. Once a street is plowed, it isn't excludable. But it is rival, especially right after a big snowfall, since plowing one street means not plowing another street.
(3) Education is a private good (with a positive externality). It is excludable, since someone who doesn't pay can be prevented from taking classes. It is rival, since the presence of an additional student in a class reduces the benefits to others.
(4) Rural roads are public goods. They aren't excludable and they aren't rival since they're uncongested.
(5) City streets are common resources when congested. They aren't excludable, since anyone can drive on them. But they are rival, since congestion means every additional driver slows down the progress of other drivers. When they aren't congested, city streets are public goods, since they're no longer rival.
