Question

In: Economics

Short   Answer   (50   points)   1. In   Smalltown,   USA,   Big   Corporation   serves   as   a   monopoly   in  

Short   Answer   (50   points)   1. In   Smalltown,   USA,   Big   Corporation   serves   as   a   monopoly   in   the   electricity   market.   The   demand   for   electricity   is   given   by   ? = 1020 − 2?!.   Marginal   revenue   is   given   as   ??=1020−4?!.   ?   is   measured   in   thousands   of   households.   Providing   electricity   to   an   additional   household   costs   Big   Co.   $20.   In   addition,   Big   Co.   uses   outdated   technology   that   produces   harmful   emissions   to   the   local   atmosphere.   As   a   result,   scientists   have   concluded   that   providing   each   household   with   electricity   results   in   an   external   cost   of   $100,   in   the   form   of   chronic   health   problems.   a. Draw   and   label   the   following   on   the   graph:   ??,???,???,???,???.  

b. Calculate   the   equilibrium   price   and   quantity   without   any   government   interventions.   Label   this   quantity   on   the   graph   as ?!and   ?!,   respectively.  

c. Calculate   and   label   the   consumer   surplus,   producer   surplus   and   external   cost   at   QM.   d. (2   points)   Is   ?! efficient?   Why   or   why   not?  

e. Calculate   the   efficient   quantity.   Label   this   quantity   on   the   graph   as   ?!.  If   the   government   would   like   to   make   sure   that   no   more   than   the   efficient   quantity   is   produced,   should   they   enact   a   policy   to   make   the   firm   “internalize   the

Solutions

Expert Solution

a. The graph can be seen in the picture below. Here, the MPC=MC (and hence the supply curve) is a straight line as is the MSC=MPC+MEC, because they are not dependent on the quantity sold as given in the question.

b. The equilibrium price and quantity can be calculated as follows -

We equate MR with MC

1020 - 4Q = 20

4Q = 1020 - 20

4Q = 1000

Q = 1000/4

Q1 = 250

P1 = 20

c. The Consumer Surplus can be seen from the shaded region in the diagram below -

To get the value of this region, we need the value of Q2, which is the socially efficient quantity ad obtained in part e below as 225. To get the point where the demand curve intersects with the y-axis, we substitute the value '0' in place of Q in the equation of demand given in the question and subtract the value of P1 from it. We get the point as (1020 - 2*0) = 1020 - 20 = 1000

Hence, the value of CS is = 1/2 * 225 * 1000 = 112500

There is no porducer surplus in this case because the supply curve is perfectly elastic.

d. Q = 250 is not efficient because at this stage the marginal external cost is greater. It may be efficient for the firm, but t has externality effects and is not efficient for the environment and for the society on the whole.

e. The efficient quantity Q2 can be calculated by equating the MSB with the MSC.

Here, MSB is the MR that the firm earns. The MSC is the MC + MEC

MSC = 20+100

Efficient quantity -

MR = MSC

1020 - 4Q = 120

4Q = 1020 - 120

4Q = 900

Q = 900/4

Q2 = 225

Yes, the government should make a policy to internalise this externlity. The way to do this is to tax the output of the firm, so that they can be disincentivised to produce more than the efficient quantity


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