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