Question

Suppose the government is considering an increase in the toll on a certain stretch of high-way from $0.40 to $0.50. At present, 50,000 cars per week use that highway stretch; after the toll is imposed, it is projected that only 40,000 cars per week will use the highway stretch.

(a)(15 pts) Assuming that the marginal cost of highway use is constant (i.e., the supply curve is horizontal) and equal to $0.40 per car, what is the net cost to society attributable to the increase in the toll? (Hint: the toll increase will cause the supply curve, not the demand curve, to shift.)

(b)(15 pts) Because of the reduced use of the highway, the government would reduce its purchases of concrete from 20,000 tons per year to 19,000 tons per year. Thus, if the price of concrete were $25 per ton, the government’s cost savings would be $25,000. However, the government’s reduced demand for concrete causes its market price to fall from $25 to $24.50 per ton. Moreover, because of this reduction in price, the purchases of concrete by nongovernment buyers increase by 300 tons per year. Assuming that the factor market for concrete is competitive, can the government’s savings of $25,000 be appropriately used as the measure of the social value of the cost savings that result from the government purchasing less concrete? Or would shadow pricing be necessary?

Answer 1

(a) suppose Government increase in toll on a certain stretch of highway.
By this caused a deadweight loss occours and the resulting full in the number of cars using the highway.
Deadweight loss =(0.5)(.50-.40)(50,000-40,000)
=$500
The increased toll paid by other remaining drivers (.50-.40)(40,000) can be viewed as transfer from drivers to the government.

(b) Because of the reduced use of highway,the goverment would reduce its purchase of concrete from 20000 to 19000 tons per year.Part of the goverenment 25000 savings from purchasing less concrete are offset by a reduction in surplus receieved by by the producers of concrete.
Annual loss of producer = (.5)(25-24.5)(1000)=250
Thus, the social value of saving = 26200-250
= $24750

So,the reduction in the government budgetury expenditure provides a good approximate of the social value of the savings that results from the reduced purchase of concrete and the use of shadow prices in this instance is not really necessary.