1.    External costs and benefits (Unit 12.1)

What is meant by an external cost? Why might too much of a good be produced if an external cost is ignored? Identify external costs or benefits is the following examples:

Mark driving his car to University rather than using public transport.

Sally planting a garden in her renovated home.

Charlotte playing her music loudly in a public setting

Electricity producers using brown coal to generate power for sale.

2.    Externalities and Pigouvian Taxes (Unit 12.3)

Note: In the lecture (and textbook), we have used as an example a price-taking firm to illustrate the consequences and solution to externalities. In the tutorial questions, we are considering a firm producing a differentiated product. Recall that firms       maximise profits when Marginal Cost = Marginal Revenue (see Lecture 3, slide 37  or Section 7.6 in textbook for more detail). When MC = MR, it is also true that            MRS=MRT.

Consider the problem associated with burning coal. For many individuals, the particles  released when brown coal is burnt imposes health costs on those who live in the vicinity of power stations where brown coal is burnt. Suppose that the marginal private cost       curve (MPC) and the marginal revenue curve (MR) for a power station are shown in the diagram below. The marginal external cost curve is also shown in the diagram.

In the absence of any corrective action, how much brown coal will be burnt? Using a    diagram, show how to identify the optimal level of brown coal that should be burnt?     Using a diagram, show how a Pigouvian tax may be imposed on the operators of brown coal power stations to achieve an optimal outcome?

Discuss other possible solution (other than the Pigouvian tax) to tackle the issue.

($)

MEC

MR

Qty (000 Mgw)

5000

3.    Externalities and Compensation (Unit 12.3).

Consider the problem identified in question 2. Assume that rather than a tax the              government legislated that power stations that burn brown coal must compensate any     individuals who are harmed. What is the new MPC for the power station? How much     electricity will they produce and identify how much compensation they will pay to those who are harmed.

4.    Externalities and Bargaining (sec. 12.2).

Consider again the problem identified in question 2. How might bargaining between the power station and local residents ensure that we achieve a Pareto efficient outcome? In a diagram identify the maximum amount that residents would be prepared to pay to reduce output to its efficient level. In a diagram identify the minimum amount that the power     station would accept to reduce output to the efficient level. What impediments may there be to achieving a bargained outcome?

5.    Positive externalities (Unit 12.2)

We often associate externalities with pollution or congestion. Let’s consider an apple       grower operating in a competitive market, where many apple growers sell apples to many customers. Assume each tonne of apples can be sold at a price of $50. Since apple            growers are price-takers, the marginal benefit (or revenue) curve is a horizontal line         equal to the price. Assume that the marginal cost of producing apples is increasing.

One positive externality of growing apples is that they produce lots of flowers which bees from a neighbouring beekeeper use to produce honey.

Based on the diagram below, how many tonnes of apples will the grower produce if they are only concerned about maximizing their profit?

Explain why the marginal social benefit (MSB) line lies above the marginal private  benefit (MPB). Show the quantity of apples produced that would be Pareto efficient. How does it compare with the quantity chosen by the apple grower?

6.    Public goods (Unit 12.5)

For each of the following goods or bads, decide whether they private goods, public      goods, club goods or common pool resources, by referring to whether they are rival vs. non rival and excludable vs. non-excludable, and explain your answer. If you think the answer depends on factors not specified here, explain how.

a)  A free public lecture held at a university lecture theatre

b)  Noise produced by aircraft around an international airport

c)  A public park

d)  A forest used by local people to collect firewood

e)   Seats in a theatre to watch a musical

f)   Bicycles available to the public to hire to travel around a city