Question

4. Poway is a town that has 70 families with a child, and 30 without a child. 30 of the families with a child are willing to pay as much as $6,000 to educate their child, and 40 are willing to pay as much as $4,000 to educate their child. Each educated child creates a positive externality of $30 for each family in Poway but the cost of educating a child in Poway is $5,000.

(a) Without regulation, how many residents educate their child?

b) With regulation, how many residents educate their child?

c) What is the change in social profits by regulating the externality?

Residents of the town of Los Locos (population 100) like to drive noisy off-road vehicles, but they hate the disturbance and dust caused by each others’ vehicles. Each vehicle purchased by a resident causes $10 worth of damage to each of the 100 residents. Forty residents are willing to pay up to $3,500 for an off-road vehicle, 20 residents are willing to pay up to $3,000 for an off-road vehicle, and 40 residents are willing to pay up to $2,500 for an off-road vehicle. The price of an off-road vehicle is $2,200.

(a) Without regulation, how many residents buy an off-road vehicle?

(b) With regulation, how many residents buy an off-road vehicle?

(c) What is the change in social profits by regulating the externality?

Answer 1

4. in the casestudy of POWAY

(a) Since, without regulation, the cost of education is $5000, only those families whose willingness to pay is above $5000 would educate their children i.e., 30 families will educate their children.

(b)with regulation, government can bring down the cost of education for all secions of society can avail it i.e., equal to or below $4000. now all the 70 families can educate their children.

(c)social profit is the profit which includes economic profit of firms and externalities and consumer surplus.here the positive externality will increase the social profit by means of its regulation by $210,000 ($30/child * 100 families * 70 children) from 'without regulation' level of $90,000 ($30/child * 100 families * 30 children)

in the casestudy of LOS LOCOS

(a) without regulation, price of an off-road vehicle is $2200, i.e., every resident whose willingness to pay is $2200 or more can purchase the vehicle, thus, all the 100 residents buy the vehicle.

(b) with regulation, government can increase the price of the vehicles by taxation to reduce the demand of the off-road vehicles but since nothing is mentioned about the price to be raised, we assume that price is $2200 and all the 100 residents can still purchase the vehicle.

(c)the social profits even after regulation remain the same as were at the time of without regulation i.e., social profits reduced because of the negative externality by amount of $100,000 ( $10/vehicle *100 vehicles *100 residents )