Question

12. This question is about Youngs, Olds, and global warming. Olds like driving SUVs

which causes global warming. Old people are not really hurt by global warming, but

young people are.

a. Suppose there is just one Old and one Young. Moreover, the Old has the legal

right to drive the SUV. Would the Old drive the SUV too much or too little

with respect to maximizing social surplus? (1pt)

b. If the Young and Old were to bargain over driving the SUV: (2pts)

i.

Would the Old drive the SUV more or less than without the

bargaining?

ii.

Who would give money to who?

Answer 1

a) Social surplus is maximized when the private marginal benefit to the Old and Young one equals the social cost. Driving SUV will create negative externality (rise in global warming which will hurt young one). Since Old one has the legal right to drive the SUV, they will drive it for sure (probably too much). However if they want to maximize the social surplus, the Old one has to drive less. That is the maximization of social surplus. They need to minimize the negative externality in the society. So the Old one will drive not too much or too little, but somewhere in between.

b) i) Without the bargaining the Old one will drive more SUV. Because there is no direct cost affecting them from driving and they have the legal right to drive.

ii) Since the cost is faced by the young one, which is not going to affect the Old one anyway (they are not bothered about the impacts of global warming), the Young one will pay to Old one-for reducing the SUV driving. This will help the Old one to drive less. The compensation given will be equal to the cost faced by the Young one.