ECON 201

PROBLEM SET 3

SPRING 2000

  1. The manufacture of memory chips for computers generates pollutants that generally enter rivers and streams.
  2. Use the model of demand and supply to show the equilibrium price and output of chips.

The equilibrium price and quantity will be Q1 and P1. However, this is not the socially efficient amount of output.

  1. Assuming chip manufacturers don’t have to pay the costs these pollutants impose, what can you say about the efficiency of the quantity of chips produced?

The amount of chips produced is too high because manufacturers are not fully factoring in the costs of production (including those costs imposed on others.) Efficiency could be increased if the number of chips were reduced.

  1. Show the area of deadweight loss imposed by this external cost.

The deadweight loss is represented by the shaded area in the graph.

  1. Show how a requirement that firms pay these costs as they produce the chips would affect the equilibrium price and output of chips. Would such a requirement lead to a more efficient outcome? Explain.

The equilibrium quantity would fall to Q2 and the equilibrium price would rise. This would lead to a more efficient outcome since chips would only be produced if their social cost outweighed their private benefit.

  1. For each of the following goods, indicate whether the good is a public good, a private good, a common resource or a natural monopoly. Justify your answer.
  2. Clean air

Clean air is considered a common resource. It is not excludable because you can’t prevent someone else from using it. However, it is rival because if one firm pollutes, that reduces the clean air available to everyone else.

  1. Tomatoes

Tomatoes are a private good. They are both excludable and rival. If you own the tomato, you can prevent others from eating it, and when you eat it, others can’t enjoy it.

  1. Housing

Housing is excludable and rival. If you own the house, you can prevent others from living in it. When you live in the house, others can’t enjoy it. Therefore, it’s a private good. The government may involve itself in issues of housing, but this is because of equity concerns, not issues of efficiency.

  1. Blue whales

Blue whales are common resources. There are very few of them, so if I hunt one, this diminishes everyone else’s enjoyment of the whales. Unless the government steps in, they are not excludable. However, governments have banned together to save these whales and other endangered species.

  1. Mankiw, Chapter 11, Problems and Applications, Question 1
  1. The externalities associated with public goods are positive. Since the benefits from the public good received by one person doesn’t reduce the benefits received by anyone else, the social value of public goods is substantially greater than the private value. Examples include national defense, knowledge, uncongested non-toll roads and uncongested parks. Since public goods aren’t excludable, the free-market quantity is zero, so it is less than the efficient quantity.
  2. The externalities associated with common resources are generally negative. Since common resources are rival but not excludable (so not priced), the use of the common resources by one person reduces the amount available for others. Since common resources aren’t priced, people tend to overuse them – their private value for using the resources exceeds the social value. Examples include fish in the ocean, the environment, the Town Common, and congested non-toll roads and congested parks.
  1. Suppose Acme Clothing Corp. produces jackets with a daily production function described in the table below.

Units of Labor / Jackets Produced / Marginal Product of Labor / Total Cost / Marginal Cost / Marginal Revenue / Total Profit
0 / 0 / 12 / -12
1 / 2 / 2 / 18 / 3 / 8 / -2
2 / 5.5 / 3.5 / 24 / 1.7 / 8 / 20
3 / 9.5 / 4 / 30 / 1.5 / 8 / 46
4 / 12 / 2.5 / 36 / 2.4 / 8 / 60
5 / 14 / 2 / 42 / 3 / 8 / 70
6 / 15 / 1 / 48 / 6 / 8 / 72
7 / 15.5 / .5 / 54 / 12 / 8 / 70
8 / 15 / -.5 / 60 / 60
  1. Compute the marginal product of labor for each level of labor input.
  2. Suppose the factory has fixed costs of $12 (for energy and other overhead expenses) and variable costs of $6 per unit of labor. Compute the total cost and marginal cost for each level of labor input.
  3. Suppose the jackets sell for $8 apiece. Compute the marginal revenue and the total profit for the firm at each level of labor input.
  4. What quantity of jackets will the firm produce if its goal is profit maximization? How might the firm use marginal cost and marginal revenue to find this profit maximizing point of production?

The firm will produce 15 jackets using 6 workers. The firm would use the concepts on marginal cost and marginal revenue by deciding to produce only if marginal revenue exceeded marginal cost. They wouldn’t add the 7th worker because the marginal revenue (8) is less than the marginal cost (12).

  1. Internet question: Name one monopoly firm that you deal with or from which you buy product. Find out more about the firm, its customers and its products from its web site and other reputable Internet sources. What is the source of its monopoly power? Do you think it seeks to maximize its profits? Do you think its prices are too high?