1. A drug is being produced by competitive markets at a constant marginal cost of 10 cents per dose. The demand for the drug is Q= 1,000,000 -10,000P, where Q indicates the number of doses and P is the price per dose in cents.
a. What is the market equilibrium price and quantity? Sketch your answer as well as calculate it numerically.
The companies that produce this product also discharges chemical wastes. The damage to the economy due to the pollution is estimated at 1 cent per dose.
b. An economist testifies that this drug, despite its value to society, is being overproduced. What price and quantity would the economist advocate instead? Sketch your answer. Calculate and illustrate in your graph the dead weight loss of the market equilibrium.
c. The economist suggests that a tax should be place on every dose produced. What size tax per unit of output should be imposed to achieve efficiency?
2. A modest sized city is currently considering ways of providing broad band internet service to its citizens which is not currently available. Based on analyses from other cities, they estimate that market demand in their city is P = 20 - .1Q, where Q is measured in thousands of households served and P is the price of monthly service in 10s of dollars. The marginal cost of supplying the service is P = 1 + .001Q.
A group of city counselors believes the city should own and operate the system for the purpose of maximizing net revenues (i.e., maximizing profits) Thus, the city would be the monopoly provider. The monopoly profits could be used as a stream of municipal revenues instead of property taxation.
a. If these city counselors get their way, what will be the price and quantity of broad band service in the city? Sketch your answer as well as calculate it numerically. What is the city’s mark-up over marginal cost? What is the elasticity of demand at this equilibrium?
b. If instead the city instead decides to provide the service at the efficient level, what would be the price and number of household served? What is the price elasticity of demand at this level of service?
c. Compare the monopolist vs. the efficient outcome, what is the DWL involved in allowing the city to act as a monopolist? Again, provide a sketch of your answer in addition to the calculations.
d. If the city counselors who want the city to act as the broad band internet monopoly find that basically no senior citizens take advantage of service but everyone else does, what would be the profit-maximizing lower price that they could offer to the senior citizens? How many senior citizen households would now also buy the service? What happens to the DWL?
3. Two landlords (we will call them Jim and Mary) have adjacent apartment buildings that have become very run down to the point that they have been called slumlords by other members of their community.
These two landlords know the following: If both invest in improving their apartment buildings, they will have the nicest low-rent apartments in the city and will earn high returns on their investments (say an extra profit of $5000 each).
On the other hand, if, say, Landlord Jim invests but Landlord Mary does not, then Jim will lose his shirt but Mary with benefit. This happens because of externalities. If Jim invests (say, $10,000) he will likely only realize a very small increase in demand for his apartments because they are next to a very dilapidated building. The small increase in rent he can earn (say $6000) is more than offset by the renovation costs so his net profits decrease by $4000.
But, Mary now finds her apartments in greater demand—they are low cost but they are right next to a very nice building. So, without having invested a penny, Mary’s profits increase by $6000 because of the external benefit of Jim’s renovation. The opposite will be true if Mary invests and Jim does not.
a. Use a 2x2 matrix to illustrate this situation as a prisoner’s dilemma game.
- Identify the socially efficient outcome and also identify the Nash Equilibrium of the game. Explain briefly how you know which combination of strategies is the Nash Equilibrium.
- Can you imagine a policy that might help Jim and Mary out of this dilemma? In other words, a policy that would lead to both buildings being renovated.