Skip to main content

Exercise: market failure

An industry for good X faces the following demand and marginal cost functions:

  • What output will the industry choose to produce? And what will be the consumer and producer surplus at that quantity?

Since the MC or supply curve is constant is must be the case that the producer surplus must be zero, as the suppliers can only sell their goods for one price only. The consumer surplus is equal to:
 
  • Pollution costs are represented by the marginal externality cost (MEC) function. From society's stand point, how many units of good X should be produced?

To find society's optimal output let the MSC equal MPB:

  • The industry is required to adopt a less polluting technology which raises the marginal cost, MC=$12. Find the output the industry choose to produce and calculate the new consumer and producer surplus.
Just as before, the producer surplus is still equal to zero. The consumer surplus on the other hand is now equal to:
  • The total benefit of reducing pollution with this new technology is estimated to be $90. Is the reduction in pollution worth its costs to the producers and consumers?
The cost the consumers face is equal to the difference between the old consumer surplus and the new consumer surplus: 


We can clearly see that it costs consumers more to switch to this technology than the reduction in pollution this technology brings.

Let's graph the problem:


Source: the problem were inspired by the exercises on pages 359-360 in Study Guide For Microeconomics, 8th edition (2013) by J.Hamilton, and V.Suslow.
Labels:
Location: New York, NY, USA

Comments

Post a Comment

Popular posts from this blog

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more

Macroeconomics: equilibrium in the AD/AS model

Real output and price level in the AD/AS model: The short run equilibrium in the AD/AS model, is when the  intersection between the short run aggregate supply curve and the aggregate demand curve determines the level of output and price level.          This short equilibrium output can be compared to the full-employment (i.e long run equilibrium) output by adding the long run aggregate supply curve in the graph.  If the difference between the short run equilibrium output and full employment output is negative than we have a recessionary gap. This could be caused by a decrease in households' consumption, a fall in private investments, or a decrease in government spending. If the difference is positive, we have an inflationary gap, where the short run equilibrium output is bigger than its full employment output. This can be caused by an increase in households expenditures, expansionary fiscal policy, etc... If the gap is zero, this means that t...
Post a Comment
Read more

Microeconomics: Shift in Supply

We recently talked about the factors that cause a shift in the demand. It is now time to discuss the factors that shift the supply curve which cause the equilibrium price and demand to change. Determinants of Supply: changes in supply are caused by changes in the price of inputs, the number of firms in the market, technology, changes in the price of related goods and services, and changes in expected prices. An increase (decrease) in the price of an input results in less (more) supply as per unit production costs rise (fall). More competition increases supply, and less competition leads to less supply. If a new firm enters the market for good X, then the supply of good X increases. Improvement in technology can result in an increase in the ability of producers to supply their products. For example, the invention of the printing press increased the supply of books. An increase (decrease) in the price of a related good leads to an increase (decrease) in the supply of the other...
Post a Comment
Read more