Question

In the following figure, the number of parties that Cassanova gives per month is measured on the horizontal axis, and dollars are measured on the vertical. MCp is the marginal cost of providing parties and MBp is Cassanova’s marginal benefit schedule from having parties.

a. Graphically, show how many parties Cassanova will host.
b. Suppose there is a fixed marginal external benefit, $ b , per party to Cassanova’s friends. Illustrate this on your graph.
c. What is the socially (no pun intended) optimal level of parties? How could the Social Committee induce Cassanova to throw this number?
d. On your graph, show the optimal subsidy per party and the total amount paid to Cas-sanova. Who gains and loses under this plan?

Answer 1

a.

The number of parties per month that would be provided privately is P.

 

b.   See schedule MSBp.

 

c.    P*. Give a per-unit subsidy of $b per party to induce the correct number of parties.

 

d.   The optimal subsidy is $b. The total subsidy = abcd. “Society” comes out ahead by ghc, assuming the subsidy can be raised without any efficiency costs. 

 (Cassanova’s friends gain gchd; Cassanova loses chd but gains abcd, which is a subsidy cost to government.)