David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 13 Welfare economics
Q MPC (£) Selling Price (£)
1 1 1 28
2 12 26
3 13 24
4 14 22
5 15 20
6 16 1 8
7 17 16
8 18 1 4
9 19 12
Polluting the air creates an externality. We know that the value of the externality is £20 for each
quantity level. On a graph with Q on the horizontal axis, plot the MPC, the marginal social costs
and the demand. Show the equilibrium in the market. Why is the equilibrium inefficient?
9 A honey firm is located next to an apple field owned by a farmer. The bees go into the apple field
and help make all the trees more productive. This in turn reduces the farmer's costs. We have a
positive externality. The total cost of the honey firm is TCH = H 2 , where H denotes the amount of
honey. For the farmer, the total cost is TCA = A 2 - H, where A denotes the amount of apples.
Assume that the price of honey is fixed at £2, while the price of an apple is fixed at £4. Write down
the profit functions for the honey firm and for the farmer. What is the profit-maximizing level of
honey produced by the honey firm? What is the profit-maximizing level of apples produced? Find the
profits earned by the honey firm and the farmer.
10 Now suppose that the honey firm and the farmer in Question 9 merge to become a single firm that
produces honey and apples. The total cost faced by the merged firm is TCM = H 2 + A 2 - H. The
prices of the two goods are the same as in Question 9. Write down the profit function of the merged
firm. Find the profit-maximizing levels of honey and apples produced. What is the total profit
obtained by the merged firm? Compare your answer with your results in Question 9. Is the
externality internalized?
1 1 Much of the economics of efficiency is about ensuring that we equate the marginal cost of producing
the last unit with the marginal benefit of that unit to the last consumer. Suppose the marginal cost
of preventing the planet overheating is £10 000 billion. How would you attempt to assess the
marginal benefit?
12 A government needs to raise £10 billion from taxes. It knows that taxes create deadweight burden
triangles, and it taxes a number of activities and products. In the most efficient outcome possible,
say whether the tax rate on each of the following should be low, average or high: (a) mobile
international capital, (b) unskilled domestic labour, (c) food, (d) tobacco.
1 3 Essay question Why do politicians pretend that trains can be made perfectly safe and hospitals
can supply all the health care that we know how to supply, when it is perfectly obvious that we do
not have the resources to do these things and that it would be highly wasteful to try?
334