Homework Group

#1 Due Thursday

Quiz Next Thursday Assignment Due Oct. 27th

Writing

Price of Good

Marginal Cost

Equilibrium Price

Equilibrium Quantity

Marginal Benefit Quantity of Good

 Static Model Time does not matter Cost/Benefit Analysis cutting down trees
Benefit > Cost => support action Cost > Benefit => oppose action

Dynamic Model Account for time

Cost/Benefit Analysis accounting for time Max [B0, B1, B2] Present Value $1 invested today at 10% interested yields $1.10 a year from now. Present Value (PV) of X one year from now is X/(1+r)2 r is the interest rate (discount rate) PV[Bn]=Bn/(1+r)n

 Exclusivity All benefits and costs accrued as a result of owning

Transferability All property rights should be transferable from one

Enforceability Property rights should be secure from involuntary

and using the resources should accrue to the owner, and only the owner, either directly or indirectly by sale to others

owner to another in a voluntary exchange

seizure or encroachment by others (ie. eminent domain)

Price of Good

Supply

Equilibrium Price

Demand Equilibrium Quantity Quantity of Good

Price of Good

Supply

Equilibrium Price

Demand Equilibrium Quantity Quantity of Good

Price of Good

Supply

Equilibrium Price

Demand Equilibrium Quantity Quantity of Good

Price of Good

Supply

Equilibrium Price

Demand Equilibrium Quantity Quantity of Good

 Efficient

Property Rights => Net Benefits are Maximized

Consumer Surplus area under the demand

curve minus the area representing cost Producer Surplus area under the price line that lies over the marginal cost curve Net Benefits = CS + PS

 Exclusivity

when the owner bears all of the consequences of his actions when the welfare of some agent (individual, household, or firm) depends on the activities under control of some other agent.
Negative externalities (external diseconomy) Positive externalities (external economy)

Externality

Price of Good

Supply

Equilibrium Price

Demand Equilibrium Quantity Quantity of Good

Price of Good

Marginal Social Cost

Marginal Private Cost

P*

Market Price

Demand Q* Market Quantity Quantity of Good

 Example,

when Duncan Hines produces brownie mix, it pollutes a small amount of cocoa powder into the air. This makes the air smell like brownies, and increase the MSB from the production of brownies.

If

property rights are welldefined, and no significant transaction costs exist, an efficient allocation of resources will result even with externalities.

 The

Pursuit of Efficiency

Legislative and Executive Regulation Direct Control Quota Cap and Trade Pigovian Tax polluter pays principle
Not always clear who pays

Pigovian Tax Problem

Suppose the demand function for gasoline is Pd = 6.5 - 0.5 Q where Q represents billions of gallons of gasoline. Suppose the supply function for gasoline is based on the firms marginal private costs and equals Ps=Q What is the market equilibrium level of output and price?

 Suppose the governments EPA determines the socially optimal amount of gasoline use is actually 3 billion gallons of gasoline. To reach this socially optimal quantity, the government is going to implement a per unit tax on the consumption of gasoline. The tax revenue from which will go to protecting the environment as determined by the EPA. What should the tax amount be? What price will the consumers pay? What price will the sellers receive? How much money will go to protecting the environment?

Pigovian Tax Problem

Price of Good

Marginal Social Cost

Marginal Private Cost

P*

Market Price

Demand Q* Market Quantity Quantity of Good

 Private Public

Goods rivalrous, excludable

Goods non-rivalrous, nonexcludable

 Genetic

Diversity

critical to species survival Useful for cross-breeding to develop superior

strains
Number

of Species

Species interdependence

Provides new sources of food, energy industrial

chemicals, raw materials, and medicines

 Graphically

non-rivalry means that if each of several individuals has a demand curve for a public good, then the individual demand curves are summed vertically to get the aggregate demand curve for the public good.

The Illinois Power Authority is considering updating its transmission substations to use smart-grid technology, which improves reliability and efficiency in the electric grid. Each time a new smart-grid meter is installed Chicago, Naperville, and Rockford customers all benefit from increased reliability of their electricity. A study was done to determine the benefit to each city as follows:
Chicago Marginal Benefit=10-0.5Q Naperville Marginal Benefit=5-0.5Q Rockford Marginal Benefit=10-1Q

What is the total marginal benefit when five smartgrid meters are installed?

 There

are two people in the world They both benefit from preserving the rainforest, with an inverse demand function
P=50-2Q
Preservation

is a public good The marginal cost of preserving the rain forest is $20 per acre. Estimate total demand, and the optimal number of acres to preserve.

Coase Theorem Problem

A chemical factory is situated next to a farm. Airborne emissions from the chemical factory damage crops on the farm. The marginal benefits of emissions to the factory and the marginal costs of damage to the farmer are as follows MB= 360 0.4 Q and MC=90+0.2Q From an economic viewpoint, what is the best solution to this environmental conflict of interest? How might this solution be achieved?

 Homework Group

#1 Due Thursday

Quiz Next Thursday Assignment Due Oct. 27th

Writing