Handelsblatt

SOLUTIONS to Problem Set #3 True or False Because drivers of cars have their own life on the line, they will exert the efficient level of care when driving. False. We can think of driver carefulness as a good with an associated positive externality. My being careful benefits me primarily, but also has spillover benefits for others on the road. I’ll be careful up to the point where the marginal benefit to me equals the marginal cost to me. But others are benefiting as well from my care, implying that the MSB curve lies above my private MB curve. Thus, I will be providing too little care, from a social welfare (efficiency) perspective. Just because my life is on the line doesn’t mean I take sufficient care to account for the external benefits. Problem Solving 1. Consider the market for slices of pizza. Suppose that the market is perfectly competitive. There are 4 consumers and 2 producers (but each acts as price taker). Consumers are identical and producers are identical. Assume that partial slices of pizza may be produced and consumed. individual demand curve: q=6-P individual supply curve: q=P Suppose there is an externality associated with pizza slices. Consumers of the pizza have a nasty habit of dropping their paper plate on the sidewalk after eating. This presents a form of visual pollution to everyone else in the area. Assume that, on average, ½ plate is dropped on the sidewalk per slice of pizza consumed. Each plate on the sidewalk causes $2 of collective unhappiness to society. a) Is this a positive or a negative externality? Negative, because it imposes costs on others. b) Is it a consumption externality or a production externality? Consumption, because it is the actions of consumers that have effects on others. c) What is the marginal external cost of a slice of pizza?

On average, 1 slice of pizza is associated with ½ plate dropped. Each plate dropped causes $2 of external damage. Therefore the marginal external cost of each slice of pizza is...