2Notes on the Problem Set Two grades: One for multiple choice and one for Essay questions – put most of the weight on essay for final gradeFor exam: would have all been saved by multiple choiceIn Exam: 40% multiple choice, 30% essay micro, 30% essay macroFeedback:Have been given points for each subquestion (max 5)Even though format similar to mock exam, there was no exam style marking scheme, so grades will vary across teachersIf you have any questions: come to my office hour today 13:30-14:30Can give you more detailed feedback
3Question 7h)Use the model of monopolistic competition to discuss what happens to domestic firms when foreign firms start selling in the domestic market.Two effects of opening to international tradedemand curve can become flatterOr damand curve can shift inwardssome firms get displaced
4ExternalitiesWhen the activity of one entity/agent directly affects the welfare of another in a way that is not captured in pricesTwo resultsSocial costs ≠ private costsSocial benefits ≠ private benefitsMissing marketsIf there are externalities Welfare Theorems no longer hold
5Question 1The London tube is one of the busiest undergrounds in the world. Whenever a commuter takes the tube during rush hours, the congestion increases. During rush hours an externality is present because:The tube is a monopolyThe tube is not properly managedThere is a missing market
6Question 2S is supply, D is demand, SMC is social marginal cost, PMC is private marginal cost, MD is marginal damage. At the level of steel output X0 there is:Too much pollution because SMC is below DToo little pollution because SMC is above PMCToo much pollution because SMC is above MDToo little pollution because SMC is below D
7The Coarse Theoremthe efficient solution will be achieved through private bargaining independently of who is assigned the ownership rights, as long as someone is assigned those rightsLimits:Cannot identify sources of damage/agents that sufferAsymmetric informationBargaining costs
8Question 3S is supply, MR is marginal revenue, SMC is social marginal cost, PMC is private marginal cost, MD is marginal damage. If the steel mill is price taker and the ownership of clean air is assigned to the forestry firm, the largest bribe the steel mill would be willing to pay for permission to produce more than X* is:More than enough to convince the forestry firm to give permissionJust enough to convince the forestry firm to give permissionNot enough to convince the forestry firm to give permission
10Question 4From time to time, used hospital waste, such as hypodermic needles from unknown hospitals, wash up on beaches. This creates an externality imposed on the public by the hospitals in terms of dirty water and unsafe beaches. In this case the Coase Theorem:Would lead to the correction of the implied externalityWould not lead to the correction of the implied externality
11Question 6“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”(Adam Smith)
12Question What is the consequence of that statement? Does this still hold if we have externalities?What about if the Coarse Theorem doesn’t holdReal life examples of externalities: PollutionWhy does the Coarse Theorem not work here?Missing markets – how can the government intervene?
13Correcting for Externalities What is a Piguvian Tax?A corrective tax that alignes the private marginal cost with the social marginal costOther ways to intervene:Regulation/legal interventionsCreating a market/effluent feeWhat would be the optimal strategy in the case of pollution?
14Question 5If each pack of cigarettes smoked creates 68 pence of externalities borne by other members of society (in terms of the costs of cigarette smokers’ excess use of health services, of foetal death, and of second-hand smoke), the situation can be corrected by a Pigouvian of:68 pence32 pence34 pence16 pence