Question

City residents complain about the noisy customers of the city’s bars. The Council decides to fine each bar in the area a fixed amount of $100. Assume Joe's Bar is just one of many in the area so the perfect competition model can be used.

a. Use graphs to show the effect of the fine on the price charged, the quantity of drinks served and the profits at Joe's in the short run and long run.

b. How would your answer to a be different if Joe’s Bar was the only one in the city? (i.e. Joe’s bar has a monopoly) Explain your answer.

c. Is the noise created by Joe’s customers an externality? Explain. Will the tax increase or decrease deadwight loss?

Answer 1

c. Is the noise created by Joe’s customers an externality? Explain. Will the tax increase or decrease deadweight loss?

Joe's bar creates a negative externality of production. It means marginal social cost is more than marginal private cost. Production is more (Qm )than optimum (Opt).As shown in diagram below tax imposed will shift supply to left with increase in price and social optimum Quantity is produced at Qopt. A tax imposed will shift Supply curve to left and optimum quantity can be produced.This aims at reducing dead weight loss. As MPC shifts to MSC deadweight loss will be reduced.

a.Let us say, it was in perfect competition then,Prices charged (P1)are equal to average total costs(ATC1). In short run, average total costs will go up to ATC2 and prices will not change for one firm and hence demand will remain the same. It will have loss. In the long run however, they will again get normal profit as inefficient firms will go out and prices charged will go up from P1 to P2 again getting normal profits.

Refer diagram below.

b. If they are in monopoly then they will raise price and will try to cover this increased cost and pass the burden on customers. This will result in immediate price rise in the short run. and quantity demanded will go down with decreased profit for Joe's bar. In the long run again more profits can be taken as there is no substitute.