Assignment 3 Public Economics IIT Kanpur Fall 2012 1. A, B, and C live in IIT-Kanpur.

As demand for a flyover bypassing the GT road, a public good, is given by Q = 12 2P. Bs demand is Q = 18 P, and Cs is Q = 8 P/3, (where Q is the length of the flyover). The marginal cost of building a flyover is MC = 21. The citys government decides to use the following procedure for deciding how long a flyover to build. It asks each resident how long a flyover they want, and it builds the longest one asked for by any resident. To pay for the construction, it then taxes A, B, and C the prices a, b, and c per km, respectively, where a + b + c = MC. (The residents know these tax rates before stating how long a flyover they want.) i. If the taxes are set so that each resident shares the cost evenly (a = b = c), how long a flyover will get built? ii. Show that the government can achieve the social optimum by setting the correct tax prices a, b, and c. What prices should it set? 2. A Metro city added a new metro station in a neighborhood between two existing stations. After the station was built, the average house price increased by 10,000 and the average commute time fell by 15 minutes per day. Suppose that there is one commuter per household, that the average commuter works 5 days a week, 50 weeks a year, and that the benefits of reduced commuting time apply to current and future residents forever. Assume an interest rate of 5%. Produce an estimate of the average value of time for commuters based on this information. 3. Garlic City is a major producer and supplier of garlic. Unfortunately, the stench of garlic permeates all aspects of life in the city. There are only two residents willing to live within city-limits, A and B. A earns an income of 460, and B earns an income of 440. A traveling salesman is visiting the city, offering odor conversion units which conveniently inputs garlic odor and outputs clean air. Preferences over clean air (C) and all private consumption goods (xi) for individual i are given by: Ui = 5 ln(xi) + ln(C) The total provision of clear air is given as the sum of individual purchases: C = CA + CB (+CG when the local government purchases clean air in parts (4)-(5)). The price of clean air is 2 while the price of all other consumption goods is 1. i. For both A and B, calculate each individuals private provision of clean air, taking the other's provision as given. That is, solve for CA as a function of CB in As optimization problem (and solve for CB as a function of CA in Bs optimization problem). Can you explain the sign on the contribution of the other resident in these response functions?

Eco535| Tanika Chakraborty

ii.

If the government does not intervene, what level of clean air will be provided? How many units are provided by A? How many by B? What is the socially optimal level of clean air provision? (You may assume a utilitarian social welfare function) Does this value differ from that found in (2)? Explain in the context of externalities. Suppose the local government is dissatisfied with the level of private provision. The government taxes both A and B 30 each in lump-sum fashion (net-of-tax incomes are effectively reduced to 440 and 410 respectively) to provide 30 units of clean air. Both A and B are free to purchase additional units of clean air if they find it privately optimal to do so. What is the total level of clean air provided? Clearly explain the impact of the taxation/provision by the local government on the private provision by each resident. How does this answer compare to (2)?

iii.

iv.

Eco535| Tanika Chakraborty