ECO 330T – POLITICAL ECONOMY

ECO 330T
POLITICAL ECONOMY
SPRING 2017

HOMEWORK #3
(due 2/8)

1. Consider an
economy with 5 identical consumers who each have the demand function below for
a public good. The economy’s supply
schedule is on the right.

Individual Market
Demand Supply
P Q P Q P Q P Q
10 1 5 6 32 1 52 6
9 2 4 7 36 2 56 7
8 3 3 8 40 3 60 8
7 4 2 9 44 4 64 9
6 5 1 10 48 5 68 10

a) Find the Pareto Optimal quantity of the good. (1 point)
b) Assume people are
surveyed, asked to reveal their demand curve and told they will pay their
stated price for the good. How much of
the good gets produced if 4 people tell the truth, but one person lies and says
they do not care for the good. Explain why the liar benefits from this
scheme. What if everyone follows this
scheme. (2 points)
c) Would it help
solve the free-rider problem if the provider of the public good knew the
consumers had identical preferences? By
this, I do not mean the provider knows what the preferences are, just that everyone
is the same. Explain. (1 points)

6. Assume there is a
firm which produces a type of pollution which it would be willing to eliminate
for $500. There are 3 households that
live far away from each other but are the only ones affected by the pollution. These 3 households would be willing to pay
$100, $200, and $300 respectively to eliminate the pollution from the firm.

a) Explain whether or not it is efficient for the firm to
keep polluting. Explain what happens if
a court grants the “pollution rights” to the households. (1 point)
b) Explain the result
if a court awards the pollution rights
to the firm, and a lawyer charges each household $50 to negotiate a
settlement with the firm. No fee is paid
if a settlement is not reached. (1
point)

3. Textbook, Page 190
– 191. Problems 2, 3 and 5. (3 Points)

4. Consider an event
which has a probability of occurring to any individual = 0.01 once each year,
and never occurs twice in a year.. If
this event occurs, it costs the person $100,000.

a) Explain why a
company could stay in business if it sold insurance which covered their losses
if this event occurs to them, but charges them $1200 per year for the
insurance. (1 point)
b) Explain why people
might be willing to buy this insurance.(1 point)

Now assume that, there are instead, two types of people in
the world. Half the population has a
probability of this event occurring = 0.0005, the other half have a probability
of 0.0195. The cost is the same to each
group if the event occurs.

c) Explain why, if an
“average” person buys the insurance, the insurance company still makes money.
(2 points)
d) Explain why now,
it is less likely people in one of these groups will buy the insurance. Explain why either the insurance will no
longer be offered, or how only one of the groups will be willing to buy it? (2
points)