PROBLEM SET 4 — Tutorial Week 6 (September 14–18)

Deadline: Three days before your tutorial. Please submit in groups of 2–3 within your tutorial group. Write your
full names (as on the roster) in alphabetical order. Name your PDF “PSet # – LastName LastName LastName,”
e.g., “PSet 4 – Banerjee Duflo Kremer.” You only need to submit your answers to Section B.

Section A
1. Read the following article:
The New York Times. August 27, 2000. “A Tale of Two Fisheries.”
http://www.nytimes.com/2000/08/27/magazine/a-tale-of-two-fisheries.html
(a) Use the concept of “tragedy of the commons” to explain why the fish and lobster populations
in New England have declined so drastically since the early 1970’s.
(b) In what scenarios are harbor gangs effective? Where do harbor gangs fail?
(c) How have the Canadian and American governments been helping (or hurting) fishermen?
(d) Why is lobstering in Australia more lucrative than lobstering in New England?
(e) How did Australia end up with the world’s premier tuna ranches?

2. Greater consumption of alcohol leads to more motor vehicle accidents and thus imposes costs
on people who do not drink and drive.
(a) Illustrate the market for alcohol, labeling the demand curve, the social value curve, the supply
curve, the social cost curve, the market equilibrium level of output, and the efficient level of
output.
(b) On your graph, shade the area corresponding to the deadweight loss of the market
equilibrium. Explain. (Hint: The deadweight loss occurs because some units of alcohol are consumed
for which the social cost exceeds the social value.)

3. Categorize the following into private good, public good, natural monopoly, and common
resource. Explain.
(a) Police protection (c) Rural roads
(b) Street cleaning (d) City streets

4. Both public goods and common resources involve externalities.

(a) Are the externalities associated with public goods generally positive or negative? Use examples
in your answer. Is the free-market quantity of public goods generally greater or less than the
efficient quantity?
(b) Are the externalities associated with common resources generally positive or negative? Use
examples in your answer. Is the free-market quantity of common resources generally greater
or less than the efficient quantity?

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EC1101E Semester I, 2020/21

5. Evaluate the following statements. Do you agree? Why or why not?

(a) “A tax that has no deadweight loss cannot raise any revenue for the government.”
(b) “A tax that raises no revenue for the government cannot have any deadweight loss.”
(c) “The benefits of corrective taxes as a way to reduce pollution have to be weighed against the
deadweight losses that these taxes cause.”
(d) “When deciding whether to levy a corrective tax on consumers or producers, the government
should be careful to levy the tax on the side of the market generating the externality.”

6. Hotel rooms in Damascus go for $100, and 1,000 rooms are rented on a typical day.
(a) To raise revenue, the mayor decides to charge hotels a tax of $10 per rented room. After the
tax is imposed, the going rate for hotel rooms rises to $108, and the number of rooms rented
falls to 900. Draw a graph showing tax revenue and deadweight loss. Calculate the amount
of revenue this tax raises for Damascus and the deadweight loss of the tax.
(b) The mayor now doubles the tax to $20. The price rises to $116, and the number of rooms
rented falls to 800. Draw a graph showing tax revenue and deadweight loss. Calculate tax
revenue and deadweight loss with this larger tax. Does tax revenue double, more than double,
or less than double? Does deadweight loss double, more than double, or less than double?

Section B
1. The supply of jeans is described by 𝑄 " = 20 + 5𝑃, and the demand for jeans is described by
𝑄) = 300 − 2𝑃.
(a) Graph the market for jeans. What is the equilibrium price and quantity?
(b) Suppose that most of the buyers of jeans are teenagers. Government official X wants to
protect buyers from paying high prices, and suggests a price ceiling of $30 per pair of jeans.
Explain in detail what happens to the market for jeans, and calculate the resulting shortage.
If a black market surfaces, what is the black market price for a pair of jeans?
(c) Government official Y points out that with a subsidy of z dollars, buyers will also pay $30 per
pair of jeans. Find the subsidy, z. Indicate the deadweight loss on a graph.

2. (a) Is (the consumption of) education a private good or a public good? What are the justifications
for the public provision of education? You may consider different levels of education —
kindergarten, primary, secondary, and tertiary.
(b) Is (the consumption of) potable water rival? Excludable? What sort of good is it? What about
the provision of potable water? Are there justifications for the public provision of potable
water?
(c) How should the dissemination of news (e.g., newspapers, magazines, internet, television,
radio) be classified? What about the consumption of news? What are the policy implications
of classifying the dissemination of news as a public good?

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EC1101E Semester I, 2020/21

3. Read the following article:

The Economist. May 23, 2020. “The world urgently needs to expand its use of carbon prices.”
https://www.economist.com/briefing/2020/05/23/the-world-urgently-needs-to-expand-its-use-
of-carbon-prices
(a) To keep the rise in global temperature well below 2°C compared with pre-industrial levels,
what should the price of greenhouse-gas emissions be? What are the current prices of
greenhouse-gas emissions?
(b) When do prices change behavior? When do prices not change behavior? Cite examples of
each case.
(c) What are the different options for using the carbon-tax revenue? What are the pros and cons
of each option?
(d) The first-best option is a single carbon market. Why?
(e) In the absence of a single carbon market, “border carbon adjustment” (BCA) mechanisms
have been proposed. How do BCA’s work in theory?
(f) What challenges do BCA’s face in practice?

4. Consider the market for fitness trackers. Suppose the weekly quantity demanded is given by
𝑄) = 10,000 − 80𝑃, and the weekly quantity supplied is given by 𝑄 " = 20𝑃, where 𝑃 is the
price per unit. (Hint: Drawing graphs will be helpful.)
(a) What is the equilibrium price and quantity?
(b) Calculate consumer surplus, producer surplus, and total benefits when the market is in
equilibrium.
(c) Find the value of the deadweight loss (dollars per week) if a price ceiling of $80 is imposed
on this market.
(d) Find the value of the deadweight loss (dollars per week) if a price floor of $110 is imposed
on this market.
(e) What does deadweight loss mean? Describe in words how to find the deadweight loss in a
graph.

5. Suppose the government currently raises $100 million through a $0.01 tax on widgets, and
another $100 million through a $0.10 tax on gadgets. If the government doubles the tax rate on
widgets and eliminates the tax on gadgets, would it raise more money than today, less money, or
the same amount of money? Explain. (Hint: Consider the case when neither the supply curve nor the
demand curve for widgets is perfectly inelastic, and the case when either the supply curve or the demand
curve for widgets is perfectly inelastic.)

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EC1101E Semester I, 2020/21

6. A local drama company proposes a new neighborhood theater in Clementi. Before approving
the permit, the city planner completes a study of the theater’s impact on the surrounding
community.
(a) One finding of the study is that theaters attract traffic, which adversely affects the
community. The city planner estimates that the cost to the community from the extra traffic
is $5 per ticket. What kind of an externality is this? Why?
(b) Graph the market for theater tickets, labeling the demand curve, the social marginal benefit
curve, the supply curve, the social marginal cost curve, the market equilibrium level of
output, and the efficient level of output. Also show the per-unit amount of the externality.
(c) Upon further review, the city planner uncovers a second externality. Rehearsals for the plays
tend to run until late at night, with actors, stagehands, and other theater members coming
and going at various hours. The planner has found that the increased foot traffic improves
the safety of the surrounding streets, an estimated benefit to the community of $3 per ticket.
What kind of an externality is this? Why?
(d) On a new graph, graph the market for theater tickets taking into account both externalities.
Label the demand curve, the social marginal benefit curve, the supply curve, the social
marginal cost curve, the market equilibrium level of output, and the efficient level of output.
Also show the per-unit amount of both externalities.
(e) Propose a government policy that would result in an efficient outcome.
(f) Identify the concepts highlighted in this question. Draw a graph for the case where the
positive externality exceeds the negative externality. Draw a graph for the case where the
positive externality equals the negative externality.