CHAPTER 15 - GOVERNMENT’S ROLE IN ECONOMIC EFFICIENCY
PROBLEM SET
a.
No. The farmer will shut down, since he cannot cover his variable costs. In this case, the
positive externality results in an inefficient outcome.
Since the legal right to the pollination services are clear, the farmer and the beekeeper can reach an
agreement that will produce an efficient outcome. The farmer can make a side payment of $15
increasing the beekeeper’s revenues to $35.
Since the farmer cannot be compelled to pay the beekeeper for the pollination services, the solution
would be a government subside of $15 per day to maintain an efficient level of honey output.
4.
The deadweight loss per period before government intervention is $30,000*(1,000,000 –
800,000)/2 = $3 billion.
6.
a. The efficient level of production is QA.
b. The “fair rate of return” level of production is QB.
c. The unregulated level of production is QC.
Chapter 15 Government’s Role in Economic Efficiency
8.
Dollars
SBefore Subsidy
$114,000
$30,000
SAfter Subsidy
A
$100,000
$84,000
B
D
Z
800,000
10.
1,000,000
Number of
Degrees per
Year
a. Adverse selection.
b. Principal agent.
c. Moral hazard.
d. Negative externalities.
MORE CHALLENGING QUESTIONS
12. a. Assuming that the land will continue to generate $50,000 annual income forever, the value
of the land will be $50,000/0.10 = $500,000.
b. The minimum amount Haney will accept for restricting use of his land will be $300,000.
This is because the value of the land in residential use is only $20,000/0.10 = $200,000.
Thus, by limiting the land to residential use, Haney would lose $500,000 – $200,000 =
$300,000.
c. If Douglas and Ziffel offer Haney a total of $350,000, then Haney would be made better
off. He is willing to restrict the use of his land for $300,000, so he would benefit by
$50,000. Douglas and Ziffel would be no worse off because each is willing to pay the
amounts stated to end pig farming.
d. If Douglas and Ziffel offer a total of $300,000, then Haney would be neither better nor
worse off. Ziffel, likewise, would be neither better nor worse off if he pays the maximum
he is willing to pay. Douglas, however, would be better off if the deal is struck. He is
willing to pay $200,000, but only has to pay $150,000, so he benefits by $50,000. Thus,
the action would, indeed, be a Pareto improvement.