Chapter 14 Economic Efficiency and the Role of Government (Part II)
Review Questions
2. a. A Pareto improvement. This is a voluntary exchange, so both parties must benefit.
b. A Pareto improvement. Going to the movie is a voluntary decision for both you and your friend, so both of you must gain.
c. Not a Pareto improvement (since you were harmed), although this could become a Pareto improvement if your friend compensates you for your loss through a side payment.
4. In a perfectly competitive market with no market failure, providing more than the equilibrium quantity cannot be economically efficient, because reducing output by one unit will increase total net benefits.
6. a. Criminal law limits exchanges to those that are voluntary. Voluntary exchanges lead to Pareto improvements. Involuntary exchanges, such as robbery, always harm at least one party.
b. Property law gives precisely defined, enforceable rights over goods. If property rights are poorly defined, people waste resources trying to take away another person’s property—an activity that makes at least one party worse off—instead of devoting resources to Pareto improvements.
c. Contract law enhances efficiency by extending the range of Pareto improvements that can take place. In particular, it enables Pareto improvements that involve the future actions of some other party.
d. Tort law deals with relationships between people or businesses not linked by contracts. It creates incentives for businesses and individuals to account for the effects of their actions on others, thereby engaging in fewer acts that hurt others, and enhancing efficiency. Tort law also protects against fraud, thereby reducing the transactions costs associated with doing business.
e. Antitrust law helps sustain and improve competition in industry by preventing certain practices that would limit competition and prevent Pareto-improving production from taking place.
8. The Coase theorem addresses market failure due to externalities. When side payments can be negotiated and arranged without cost, the private market will solve the externality problem on its own.
10. Marginal cost measures the cost to the producer of producing another unit of a good, while marginal social cost measures the full cost of producing another unit of a good, including the marginal cost to the producer and any harm caused to third parties.
12. A pure public good is one that is nonrival—consumption by one person does not affect the amount available to be consumed by others—and nonexcludable—there is no way to force consumers to pay for the good. A pure private good, by contrast, is rival and excludable.
Problems and Exercises
2.
4. a.
b. See graph in part (a).
c. The dollar value of market consumer surplus = ((1.50 - $1.30) x 4000)/2 = $400. The dollar value of market producer surplus = ((1.30 - $1.10) x 4000)/2 = $400. The total net benefits in the market at equilibrium = $400 + $400 = $800.
6. a. Market consumer surplus = (($1.50 - $1.40) x 2000)/2 = $100.
b. Market producer surplus = (($1.40 - $1.20) x 2000) + ((($1.20 - $1.10) x 2000)/2) = $400 + $100 = $500.
c. Total net benefits in market = market consumer surplus + market producer surplus = $100 + $500 = $600.
d. Welfare loss = The total net benefits in the market at equilibrium – total net benefits in market = $800 (from problem 4 (c)) - $600 = $200.
8. The dollar value of the welfare loss = (($1.30 - $0.80) x 25 million)/2 = $6.25 million.
10. This is an example of the tragedy of the commons. Each roommate is getting a partial free ride in using the water paid for by the other. Since each does not consider the full costs of his actions, each is led to overuse water to the disadvantage of both.
12.
A $0.50 tax imposed on gasoline consumers would shift the demand curve down by $0.50 at each level of output. As in Figure 11 (b), the total price paid by consumers would be $1.30, the total price received by firms would be $1.30 - $0.50 = $0.80, and the equilibrium quantity would be 100 million gallons.
Challenge Questions
2. a. Assuming that the land will continue to generate $50,000 annual income forever, the value of the land will be $50,000/0.10 = $500,000.
b. The minimum amount Haney will accept for restricting use of his land will be $300,000. This is because the value of the land in residential use is only $20,000/0.10 = $200,000. Thus, by limiting the land to residential use, Haney would lose $500,000 – $200,000 = $300,000.
c. If Douglas and Ziffel offer Haney a total of $350,000, then Haney would be made better off. He is willing to restrict the use of his land for $300,000, so he would benefit by $50,000. Douglas and Ziffel would be no worse off because each is willing to pay the amounts stated to end pig farming.
d. If Douglas and Ziffel offer a total of $300,000, then Haney would be neither better nor worse off. Ziffel, likewise, would be neither better nor worse off if he pays the maximum he is willing to pay. Douglas, however, would be better off if the deal is struck. He is willing to pay $200,000, but only has to pay $150,000, so he benefits by $50,000. Thus, the action would, indeed, be a Pareto improvement.
Economic Applications Exercise
2. a. Answers may vary.
b.