1. ECON 1001 Tutorial 11

2. Q1)Which factor, if it were present, would lessen the ability of the Coase Theorem to solve an externality? A)The situation is already efficient. B)Negotiating requires hiring a lawyer. C)The parties are all self-interested. D)The potential gain in surplus is high. E)Property rights have already been assigned to one of the parties. Ans:B

3. Coase Theorem states that without any transaction costs, any allocation of property rights would be efficient because externalities will be traded privately among economic agents. Hiring a lawyer is a kind of transaction costs – one has to spend time to find a lawyer, as well as paying the lawyer to do the negotiation. In other words, in order to exercise one’s right, the person has to incur some transaction costs. Therefore, Option B is the answer.

4. Q2)If the cigar smoker paid each other occupant $0.50 for the right to smoke, the cigar smoker would be ? and the other occupants would be ?. A)Better off; worse off. B)Better off; just as well off as before the payment. C)Better off; better off. D)Just as well off as before the payment; better off. E)Worse off; just as well off as before the payment. Ans:B

5. According to the story: –The smoker’s reservation price for smoking is $5. –Each of other occupants’ reservation price for clean air is $0.50. (= instead of having clear air, they agree to be paid $0.50 to endure smoky air) Now the smoker is paying to compensate the other occupants from the smoky air.

6. There are 9 other occupants. Each of them is paid $0.50, which is their reservation price. Before the payment, they were enjoying clean air which was valued also at $0.50 (but not actually pocketing $0.50 when air was clean). Therefore, they are equally well off as before the payment.

7. The smoker’s reservation price for a drag is $5. He is paying $0.50 x 9 to smoke, which amounts to $4.50. There is a $0.50 surplus. Hence, he is better off.

8. Q3)Suppose Paul has offered to pay Sid $3500 per month to cease development. If Sid accepts Paul’s offer, it would A)Make Paul worse off and Sid better off. B)Make both Paul and Sid better off. C)Make both Paul and Sid worse off. D)Generate deadweight loss. E)Make Paul better off and Sid worse off. Ans:B

9. According to the story, –Paul values his view at $5000. –Sid could have earned $10000 with his development. –Sid’s SECOND BEST alternative earns him $7000.

10. As Paul is paying Sid a price less than his valuation for a clear view, ($5000-$3500), he is enjoying some surplus, and hence is better off. As Sid is paid $3500 not to develop the land, he can then pocket this money, and carry out his SECOND BEST plan, which makes him $7000. In total, Sid will be earning $10500 in cash, hence he is better off as well.

11. Q4)The least costly solution to the external cost is for A)Curly to endure Moe’s snoring. B)Both to live alone. C)Moe to eliminate his snoring. D)Moe to find a fellow snorer to live with. E)Moe to pay Curly for his discomfort. Ans:C

12. According to the background information: –One-bedroom flat is $500/month. –Two-bedroom flat is $800/month. –Moe has a seriously snoring problem. –Curly values a good night’s sleep at $150/month. –Snore-eliminating device costs $50/month.

13. There are 3 possible ways for Curly and Moe to arrange for their accommodation. 1.Each rents a 1-bedroom flat, costing them $1000/month in total. 1.Curly and Moe share a 2-bedroom flat while Curly cannot sleep well. This costs them $950/month in total (800 + 150). 1.Curly and Moe share a 2-bedroom flat. Moe uses a snore-eliminating device, costing them in total $850/month (800 + 50).

14. Of the 3 feasible ways, the 3rd costs them the least. Therefore, the two should become housemates. And, at the same time, Moe should use the device to eliminate his loud snoring.

15. Q5)Assume that Curly and Moe choose to divide the change in surplus from living together equally, and apply it to their monthly rent payments. As a result, Moe will pay ? /month in rent, and Curly will pay ? /month in rent. A)$425;$425. B)$400;$400. C)$350;$450. D)$375;$425. E)Neither amount can be determined. Ans:D

16. Calculating the surplus from living together: –If Curly and Moe each rents a 1-bedroom flat, they have to pay $1000/month in total. –Now, the rent for a 2-bedroom flat is just $800/month, so they have saved $200 in total. –However, in order to live together in harmony, a snore-eliminating device has to be bought. –Therefore, the total surplus they have together is $150 (1000 – 800 – 50).

17. Curly’s maximum willingness to pay for rent in a shared 2-bedroom flat is $500 - $75 = $425. (500-150/2) Because Moe has no problem with his own snoring, his maximum willingness to pay will be $375. (500-150/2-50). And so, (D) is the correct answer.

18. Q6)If the highway is viewed as having a zero price, one can predict that ? drivers will be on the road between 8am and 9am. A)500 B)400 C)300 D)200 E)100 Ans:A

19. Let us look at the table to determine the answer. Marginal Benefit can be viewed as the maximum amount of money the last driver in the congestion is willing to pay instead of getting stuck in the traffic.

20. If the highway can be used free of charge, anyone with a MB>$0 would choose to use that road. Therefore, 500 drivers will be using the highway, and it is expected that everyone has to spend about 260 minutes to get through the traffic. $0

21. Q7)Suppose a toll is imposed between 8am and 9am and the price is $5 per driver. One can predict that ? drivers will be on the road between 8am and 9am. A)100 B)200 C)300 D)400 E)500 Ans:B

22. Again, let us look at the table to determine the answer. With a road toll of $5, only drivers who have MB>$5 will use the highway. There are 200 drivers valuing using the highway at more than $5, and so that is the answer.

23. Q8)The reason drivers would prefer building new roads to a $5 toll to reduce commute times is because A)Building roads is the only solution. B)They know a toll would not alter commuting behaviour. C)Cities always need new roads. D)The cost of new roads falls on all taxpayers; the toll only falls on those who use the existing road. E)Of the commitment problem. Ans:D

24. Options A and B are not right. We know that by setting a toll, the congestion on the highway can be reduced (and solved entirely). Option C does not make any economic sense at all. Option E is also not right, as we are not talking about competition or game theory.

25. If a toll of $5 is imposed, users of the highway will have to pay money out from their pocket on a ‘pay as you use’ basis. Which means the users will have to pay for what they use. This is not a problem until rational consumers realise that they can actually shift the financial burden to other people, spreading the contribution among all people in the city.

26. By having the government building more roads, all taxpayers in the cities are financing the project. Probably not all taxpayers are users of that highway anyway. Frequent highway users will find out that instead of paying $5 every single day, commuting on other people’s money (including theirs, but the cost is spread) is a bargain. And hence, Option D is the answer.

27. Q9)Relative to driving an average car, driving a larger-than-average car generates ? And driving a smaller-than-average car generates ?. A)An external cost; an external benefit. B)An external benefit; an external cost; C)An external cost; neither an external benefit nor an external cost. D)An external cost; an external cost; E)Neither an external cost nor an external benefit; an external benefit. Ans:A

28. According to the story: –Smaller cars sustain more damage in an accident. –Smaller cars generate less air pollution on average. –Every person in the economy drives at least one car.

29. That implies larger cars: –Are imposing more danger on the road to all road users. –Are generating more air pollution on average. And hence, driving larger cars generates an external cost to the economy.

30. Note that the question stated ‘relative to driving an average car’, which means we have to compare with driving an average car. Even though any kind of driving generates air pollution to the economy, we have to compare driving a smaller car with an average car.

31. Comparing to an average car, a smaller car generates less air pollution on average. Therefore, driving a smaller car is actually pulling down the average air pollution in the economy. Therefore, external benefit is generated in this sense.

32. Q10)As the average size of cars increase, the incentive to buy a smaller car A)Also increases due to cost savings at the fuel pump. B)Also increases to offset the external cost of air pollution. C)Decreases because of the increased risk of injury in an accident. D)Remains the same because car purchases depend on individual preferences. E)Decreases because automakers will have to charge a higher price for them. Ans:C

33. According to the story, smaller cars are more accident-prone. As the average size of cars in the economy increases, the road become more dangerous out there for smaller cars. As smaller cars tend to sustain the most damage in accidents, the incentive to buy smaller cars decreases because of the reason stated in Option C.