1. Consider a market where demand is P = 10 - 2Q and supply is P = Q/2. There is a positive consumption externality of $2.50/unit of consumption.

a. Calculate the market equilibrium.

b. Calculate the total surplus.

c. How can the government increase total surplus?

d. Impose the program you indicated in part c. and calculate the total surplus.

2. The government has decided to take action to reduce the pollution caused by the chemical industry. This industry is composed of profit-maximizing firms.

a. Identify one policy that the government could implement to reduce pollution.

b. Explain the effect the policy you identified in part (a) would have on each of the following for the firms in the chemical industry.

i. Marginal cost

ii. Output
iii. Price

c. Explain the effect of the policy you identified in part (a) on the efficiency of the allocation of society's resources.

3. The supply and demand for land for residential development is shown in the diagram below. The land supplied for such development comes from privately held open-space land or privately held farmland.

a. Redraw the graph above and show how an increase in income will affect the equilibrium price and quantity of land converted into residential development, assuming that land for residential development is a normal good.

b. Redraw the graph above and show how a decrease in government per-unit subsidies to farmers will affect the equilibrium price and quantity of land converted into residential development.

c. Assume that the conversion of open-space land and farmland imposes costs on the general population, which can no longer enjoy the scenic vistas.

i. Indicate whether the marginal social cost of converting land is greater than, less than, or equal to the marginal private cost of converting land.

ii. Explain whether the private market quantity of land converted into residential development is socially optimal.

4. Consider the market for education. The marginal social cost of education (MSC) and the marginal private benefit of education (MPB) are given by the following equations where Q is the number of units of education provided per year.

MSC = 10 + Q

MPB = 100 - Q

You are also told that each unit of education provides an external benefit to society of $10 per unit. This external benefit is currently not being internalized in the market.

a) Given the MSC and MPB curves, what is the current number of education units being produced by the market?

b) Is the current level of market production for education the socially optimal amount of education? Explain your answer.

c) What is the value of consumer surplus (CS), What is the value the value of producer surplus (PS), and the value of the external benefits of the current level of production.

Sum together (CS + PS + external benefits). Draw a diagram illustrating each of these concepts in the market for education.

d) Given the market level of production, what is the deadweight loss in this market?

e) Now suppose that the external benefit is internalized in this market when the government provides a subsidy of $10 per educational unit to consumers. What will be the socially optimal amount of education to provide given this subsidy?

f) Given the subsidy in (e), calculate the value of consumer surplus with the subsidy (CS'),

Calculate the producer surplus with the subsidy (PS').

g) With the subsidy, there are no longer any external benefits that the market fails to account for. Sum together CS' + PS' does this total equal the sum of (CS + PS + external benefits) + DWL from parts (c) and (d)?

5. Consider a market where demand is P=10-2Q. There is a negative production externality of $2.50/unit of consumption. Supply is equal to ?? = Q/2.

a. What is market equilibrium?

b. What is the socially optimum quantity and price?

c. If the government uses a tax to get producers to internalize the externality what is the net price received by producers?

d. Calculate the total surplus at market equilibrium

e. Calculate the total surplus at social optimum equilibrium

f. Calculate the total surplus with the tax

6. Assume that two stores occupy the Huntington Mall! These stores are facing a decision of whether or not to hire a security guard for the mall. The benefit, in the form of reduced theft, to each store of hiring the guard is 8. The cost of hiring a guard is $10. If either store hires a guard for the mall the other store will benefit just as much as if it had hired the guard (i.e. the guard is non-rival and non-excludable). Additionally, we will assume the one guard is just as good as two guards, thus, if both stores agree to hire a guard they will split the cost of one guard.

The following payoff matrix reflects the payoffs of firms engaged in the game where the stores simultaneously select whether to hire.

a. Is it socially optimal (or the best solution) for the stores to hire the guard?

b. Why or why not?

c. What is the Nash Equilibrium of the game? Is the solution a result of free riding? Explain (Free riding is the benefit one gets from a good or service without paying for it)

d. Now, solve the stores security guard problem (i.e. define a scheme you think would get them to the social optimum).