# ECN 445 FALL 2014 PROBLEM SET 3- 1 Missioni sweaters are greatly admired by their aficionados

ECN 445 FALL 2014
PROBLEM
SET 3

[Lecture:
Welfare evaluation #2] Missioni sweaters are greatly admired by their
aficionados. The demand for these sweaters is given by Q = 13 – 0.02 P, where Q
is the quantity of sweaters purchased per person per year, and P is the price
of a sweater. These sweaters typically sell at the Missioni store for \$500 per
sweater. However, in a special promotion, Target decides to offer Missioni
sweaters at a price of \$50, while limiting purchases to 2 sweaters per person.
What is the gain in consumerâs surplus for a Missioni fan who can get these
sweaters at Target instead of at the Missioni? Draw the appropriate diagram to
illustrate this gain, and also do the numerical calculation..45pt;’=”” 0cm;=”” normal;=”” 12pt;=”” roman”,serif;=”” new=”” “times=”” black;=””>For the following questions see the Lectures on
Externality: Pigou & Coase..45pt;=””>The
production of gasoline causes air pollution but the damage from this pollution
is not priced and is not factored into the price of gasoline. Markets are
interconnected, and the price of gasoline affects the cost of transportation;
the cost of transportation affects how easy it is to get people and goods,
including food, from one place to another and thus affects the value of land
for housing and the cost of food; the cost of transportation also affects the
market for cars and public transportation; and all of these affect peopleâs
budgets. Given this interconnection of markets, what are the consequences of an
unpriced (and unregulated) externality in the market for gasoline? If there are
competitive markets in all these other markets, are they likely to produce an
efficient allocation of these other goods? Explain the reasons for your answer..45pt;=””>(a)
What is the difference between a pecuniary externality and a real (physical)
externality? (b) What does the First Theorem of Welfare Economics state about
the outcome of an economy with perfectly competitive markets? (c) Which type of
externality, according to Pigou, leads to a violation of the First Theorem of Welfare
Economics, and why: explain why that type of externality leads the outcome of a
perfectly competitive economy not to maximize the public interest? (d) What
alternative remedies did Pigou prescribe? (e) Did Coase believe that either of
Pigouâs remedies was needed? If not, how did Coase see the situation being
resolved? (f) Are there circumstances in which you would find Coaseâs criticism
of Pigou unpersuasive? What circumstances?.35pt;=””>A
builder proposes a skyscraper that would block sunlight to the neighboring
houses. The building would have net benefits to the builder of \$100,000. The
neighbors, who use some solar heating, would face reduced property values and
increased heating costs totaling \$80,000..45pt;’=””>(a) The law clearly stipulates that
the neighbors have the right to solar access. Is a Paretoimproving exchange
possible? What do you expect the outcome to be?.7pt;’=””>(b)How, if at all, would the outcome be
different if the builder had the right to construct the skyscraper, even if it
blocked solar access?.7pt;’=””>(c) Suppose again that the neighbors
have the rights. Because there is a large number of neighbors, hiring an
attorney to negotiate with all of them will be expensive, perhaps as much as
\$25,000. Is a Pareto-improving exchange possible? What do you expect the outcome
to be?.55pt;’=””>(d)Now suppose that the builder has the
rights, and the costs of the lawyer (still \$25,000) belong to the neighbors. Is
a Pareto-improving exchange possible? What do you expect the outcome to be?
Compare this scenario with those of the other parts of this problem. What has
led to these different outcomes?.45pt;’=””>5.[See also Review lectures on Theory of production and
cost, and profit maximization] Acme Charcoal is a charcoal producing company in
Cleveland. Its total cost function is C(QA) = 25 + 10QA+
4QA2, where QAis charcoal production per week
in thousands of tons.
What
is the formula for the average variable cost of production?.45pt;=”” lfo2;’=”” l1=””>What
is the formula for Acmeâs marginal cost function? What portion of this marginal
cost curve lies above Acmeâs minimum average variable cost?.45pt;=”” lfo2;’=”” l1=””>If
charcoal sells in Cleveland for \$810 per thousand tons, how much charcoal will
Acme produce?.45pt;’=””>6. Acme Charcoal (continued) [Lectures on Externality:
Pigou & Coase].45pt;’=””>Clearview is an eyeglass company located near Acme Charcoal
in Cleveland. Clearviewâs production of eyeglasses is negatively affected by
the smoke from Acmeâs production of charcoal.
As
in the previous question, charcoal sells in Cleveland for \$810 per thousand
tons. This is the nineteenth century, and no pollution control laws have yet
been passed in the US. Does the fact that Acmeâs charcoal harms Clearview
change your answer to part (c) of the previous question? Explain the reason for
total cost function to produce eyeglasses is.45pt;’=””>C(QE) = 40QE+ 2QE2+
2QA where QEis
Clearviewâs weekly production of eyeglasses and QAis Acmeâs weekly
production of charcoal in thousands of tons. What is the extra cost to
Clearview from an additional thousand tons of charcoal production by Acme?.45pt;=”” lfo3;’=”” l0=””>Eyeglasses
sell for \$140 per eyeglass. How many eyeglasses would you predict that
Clearview produces per week?.45pt;=”” lfo3;’=”” l0=””>How
much profit do Acme and Clearview each earn in this situation?.45pt;=”” lfo3;’=”” l0=””>How
much higher would Clearviewâs profit be if Acme went out of business or at
least did not operate in the vicinity of Clearviewâs premises?.45pt;=”” lfo3;’=”” l0=””>If
a municipal ordinance were passed in Cleveland making a polluter in Cleveland
liable for damages caused by his pollution, what do you predict would be the
outcome in terms of Acme and Clearview? How much would each firm produce?
Explain the reasoning behind your answer..7pt;’=””>7. [Lecture on Pollution control policy] It is 2025 and
Globus Electricity company has to manage its carbon emissions from burning coal
to generate electricity. For this it must employ a carbon capture and storage
(CCS) plant to abate carbon emissions. In the absence of any abatement, Globus
would generate 50 tons of carbon. It has a CCS plant on the Westside with the
following cost function for carbon abatement: Abatement cost = 50QW + 5QW2 ,
where QW is the tons of carbon abated at that plant; the marginal cost of
abatement is MC = 50 + 10QW.
For
each ton of carbon emissions that Globus does not abate it must pay a federal
emissions tax of \$300 per ton emitted. How much carbon will Globus choose to
abate? Explain the reasoning underlying your calculation..45pt;=”” lfo4;’=”” l2=””>Why
doesnât Globus decide to abate all its emissions in case (a)?.45pt;’=””>Globus now decides that it will abate allof its emissions, rather than paying any tax on emissions. It
acquires a second CCS plant on the Eastside. This plant has as cost function
for carbon abatement given by: Abatement cost = 30QE + QE2 , where QE is the
tons of carbon abated at the east plant; the marginal cost of abatement at this
plant is MC = 30 + 2QE..6pt;=””>Given
Globusâs decision to abate all of the 50 tons of carbon, how much abatement
Globus will choose to conduct at each plant? Explain your reasoning..45pt;’=””>8. [Lecture on public goods] (a) What is the definition of
a public good? How does it differ from a conventional market good? (b) Explain
why one might see a lighthouse as a public good. Are there other transportation
related facilities that could be seen as a public good â which facility, and
how does it fit the criteria for a public good? (c) Is it possible that there
could be private provision of lighthouses? (d) Would private provision be
expected to generate a socially optimal level of provision of a public good?

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