Question

Q1: The market for gold is represented by Q = 3P – 300 and Q = 8300 – 2P where Q is ounces of gold and P is the price of gold per ounce.

Hint: Figure 5.5 on page 107 of your textbook or Chapter 5 – Graph 8 (Negative Externalities) found in Brightspace is useful for visualizing the market for gold.

a) What are the free market equilibrium price and equilibrium quantity of gold?

b) The production of gold creates negative externalities. Give and explain two (and only two) specific and distinct negative externalities associated with gold production USING YOUR OWN WORDS. DO NOT PLAGIARIZE. Unless you are very familiar with gold production, you will need to do some research to answer this question.

c) Due to the negative externalities associated with gold production, the full social cost supply of gold is represented by

Q = 2P – 500. What are the socially optimal equilibrium price and equilibrium quantity of gold?

d) Why is the free market for gold inefficient? Explain in such a way that a layperson who does not know anything about economics would understand. In other words, DO NOT use terms such as total economic surplus and deadweight loss in your answer because a layperson would not know what they mean.

e) What does the deadweight loss in the free market for gold equal? Show clearly how you arrived at your answer.

f) What is one (and only one) government intervention that would make the free market for gold more efficient AND what impact does this government intervention have on the market?

Answer 1

Q = 3P - 300

Q = 8,300 - 2P

a) At equilibrium, demand = supply

3P - 300 = 8,300 - 2P

5P = 8,600

P = 1,720

At this price, Q = 4,860

b) Negative externalities to society:

• Dust during mining affects air quality and reduce the quality of air that people inhale.
• Noise pollution due to heavy machineries used in mining process reduces quality of sleep.

c) Social cost curve: Q = 2P - 500

Socially optimal quantity occurs when 8,300 - 2P = 2P - 500

8,800 = 4P

P = 2,200

At this price, Q = 3,900

d) Free market is inefficient because it tends to produce more than socially optimum outcome which puts extra pressure on gold reserves and deplete its quality. As gold is non renewable, extraction at high rate will reduce supply of it.

e) Deadweight loss is the area of portion A whose sum is (1/2) * (4,860 - 3,900) * (2,680 - 1,720) = 460,800

f) Government can impose tax on gold producers such that it raise their cost of extracting gold which will induce them to reduce the extraction of it which will shift private supply to its leftward and might join social supply curve.