Economics 321: Public Economics Prof. Marika Cabral TA: Katherine Keisler Fall 2017 UT Austin Problem Set 2 (Due Monday, October 2nd) 1. (Ch 5) When the state of Virginia imposed stricter regulations on air pollution in 2003, it also authorized an auction of pollution permits, allowing some plants to emit larger amounts of ozone-depleting chemicals than would otherwise be allowed, and some to emit less. Theory predicts that this auction will lead to a socially efficient allocation of pollution. Describe how this outcome would occur. 2. (Ch 5) Suppose that demand for a product is Q = 1,200 – 4P and supply is Q = –200 + 2P. Furthermore, suppose that the marginal external damage of this product is $8 per unit. How many more units of this product will the free market produce than is socially optimal? Calculate the deadweight loss associated with the externality. 3. (Ch5) The marginal damage averted from pollution cleanup is MD = 196 – 6Q. The marginal cost associated with pollution cleanup is MC = 20 + 2Q. a. What is the optimal level of pollution reduction? b. Show that this level of pollution reduction could be accomplished through taxation. What tax per unit would generate the optimal amount of pollution reduction? 4. (Ch 6) Many towns and cities on the northeast and west coasts have passed bans on smoking in restaurants and bars in the past decade. a. What is the economic rationale behind these bans? b. Would there be similar rationales for banning smoking in: i. Automobiles? ii. Apartment buildings? iii. Houses?5. (Ch 5) Caffeine is a highly addictive drug found in coffee, tea, and some sodas. Unlike cigarettes, however, there have been very few calls to tax it, to regulate its consumption, or limit its use in public places. Why the difference? Can you think of any economic arguments for regulating (or taxing) it’s use? 6. (Ch 5) Imagine that it is 1970, and your parents are in college, debating the merits of the Clean Air Act of 1970. Your father supports the act, but your mother says that since it only covers new plants, it might actually make the air dirtier. a. What does your mother mean by her argument? b. How would you construct an empirical test to distinguish between your parents’ hypotheses? 7. (Ch 7) People in some neighborhoods pay annual dues to a neighborhood association. Suppose this association refunds neighborhood dues to selected home owners who do a particularly nice job in beautifying their yards. a. Why might the neighborhood association provide this refund? b. At the most recent home owners’ association meeting, home owners voted to end this practice because they feel it is unfair that some people do not have to pay their share of the costs of maintaining the common areas of the neighborhood, such as the parks and pools. What is likely to happen to the overall level of neighborhood beautification? Explain. 8. (Ch 7) The town of Springfield has two residents: Homer and Bart. The town currently funds its fire department solely from the individual contributions of these residents. Each of the two residents has a utility function over private goods (X) and total firefighters (M) of the form U = 4 × log(X) + 2 × log(M) The total provision of firefighters hired, M, is the sum of the number hired by each of the two persons: M = MH + MB. Homer and Bart each have an income of $100, and the price of both the private good and a firefighter is $1. Thus, they are limited to providing between 0 and 100 firefighters each . Hint 1: Because income is $100 and all money will be spent, spending on private goods (X) can be rewritten as 100-M Hint 2: Because Bart & Homer benefit from the firefighters the other hires, M in each individual’s utility function can be rewritten as (MBart + MHomer) a. How many firefighters are hired if the government does not intervene? How many are paid for by Homer? By Bart? b. What is the socially optimal number of firefighters? If your answer differs from a, why?9. (Ch 7) Suppose 10 people each have the demand Q = 20 – 4P for streetlights and 5 people have the demand Q = 18 – 2P for streetlights. The cost of building each streetlight is 3. If it is impossible to purchase a fractional number of streetlights, how many street-lights are socially optimal? 10. (Ch 8) A new public works project requires 200,000 hours of labor to complete. a. Suppose the labor market is perfectly competitive and the market wage is $15. What is the opportunity cost of the labor employed? b. Suppose that there is currently unemployment among workers, and that there are some workers who would willingly work for $10 per hour. What is the opportunity cost of the labor employed? Does this vary depending on the fraction of would-be unemployed workers hired for the project? c. If your answers to a and b differ, explain why. 11. (Ch 8) The city of Metropolita added a new subway station in a neighborhood between two existing stations. After the station was built, the average house price increased by $10,000 and the average commute time fell by 15 minutes per day. Suppose that there is one commuter per household, that the average commuter works 5 days a week, 50 weeks a year, and that the benefits of reduced commuting time apply to current and future residents forever. Assume an interest rate of 5%. Produce an estimate of the average value of time for commuters based on this information. 12. (Ch 8) Suppose the city of San Francisco is considering plans to build a new bridge across bay. It is considering two plans for financing this bridge. Plan A calls for the bridge to be paid for out of tax revenues, allowing anyone to freely use the bridge. Plan B calls for imposing a toll of $6 for crossing the bridge, with the remainder of the cost to be paid out of tax revenues. City planners estimate a local demand curve for hourly use of the bridge to be Qcars= 1,800 – 100P. The bridge will be able to accommodate 2000 cars per hour without congestion. Which of the plans is more efficient, and why? How would your answer change if the local demand curve increased, for example, to Qcars=2500 –