Econ 100.

2
Introduction to Microeconomic Theory and Policy
Exercise Set No. 4 [30 points]
ANSWER KEY

Question 1 [5 points, 10% each answer]

Consider the rivalry in consumption and excludability of each of the following goods. Use this information
to determine whether the goods are public goods, private goods, common resources, or produced by a
natural monopoly.

1. Cable television signals produced by a natural monopoly

2. Streetlights in UP Diliman public good
3. A congested EDSA common resource
4. An uncongested North Luzon Expressway produced by a natural monopoly
5. Specific research on a cholesterol-lowering drug for which a patent can be obtained produced by a
natural monopoly
6. An uncongested Commonwealth Avenue public good
7. Fish in West Philippine Sea common resource
8. A congested South Luzon Expressway private good
9. A hotdog sold at a stand owned by the city government private good
10. Broadcast television signals public good

Question 2 [6 points; 16.66% each answer]

Kelly and Jennifer are roommates. Kelly loves listening to rock music and uses the radio in their common
area to play it. Jennifer, on the other hand, prefers the peace and quiet around the common area.

Answer the following question given the following information:

1. Suppose the landlord tries the resolve Kelly and Jennifer’s situation by giving Kelly the right to
play rock music in the common area. The value of listening to rock music to Kelly is Php800
while the value of peace and quiet to Jennifer is Php900.
a. What is the socially efficient outcome?
a) Kelly keeps playing rock music in the common area and Jennifer tolerates it.
b) Kelly pays Jennifer to play rock music in the common area.
c) Jennifer pays Kelly to stop playing rock music in the common area and enjoys
the peace and quiet.
d) Jennifer keeps to have the peace and quiet and Kelly does not play rock music in
the common area.

b. Based on your answer in (a), what best describes the negotiation between Kelly and
Jennifer?
a) No money is exchanged since Kelly is able to keep playing rock music in the
common area.
b) No money is exchange since Jennifer is able to keep the peace and quiet in the

10/11/18 Page 1 of 6
 common area.
c) Jennifer pays Kelly at least Php800 (but no more than Php900) to stop listening
to rock music.
d) Kelly pays Jennifer at least Php800 (but no more than Php900) to play rock
music.

2. Suppose the landlord gives the right to have the peace and quiet to Jennifer. The value of playing
rock music to Kelly and the value of peace and quiet to Jennifer in the common area is the same
as in (1).

a. What is the socially efficient outcome?

a) Kelly keeps playing rock music in the common area and Jennifer tolerates it.
b) Kelly pays Jennifer to play rock music in the common area.
c) Jennifer pays Kelly to stop playing rock music in the common area and enjoys
the peace and quiet.
d) Jennifer keeps to have the peace and quiet and Kelly does not play rock music in
the common area.

b. Based on your answer in (a), what best describes the negotiation between Kelly and
Jennifer?
a) No money is exchanged since Kelly is able to keep playing rock music in the
common area.
b) No money is exchanged since Jennifer is able to keep the peace and quiet in the
common area.
c) Jennifer pays Kelly at least Php800 (but no more than Php900) to stop listening
to rock music.
d) Kelly pays Jennifer at least Php800 (but no more than Php900) to play rock
music

3. Suppose the values are changed. The value of peace and quiet to Jennifer is Php950 while the
value to Kelly of listening to rock music is Php1000. The landlord gives the right to Jennifer to
have the peace and quiet in the common area.

a. What is the socially efficient outcome?

a) Kelly keeps playing rock music in the common area and Jennifer tolerates it.
b) Kelly pays Jennifer to play rock music in the common area.
c) Jennifer pays Kelly to stop playing rock music in the common area and enjoys
the peace and quiet.
d) Jennifer keeps to have the peace and quiet and Kelly does not play rock music in
the common area.

b. Based on your answer in (a), what best describes the negotiation between Kelly and
Jennifer?
a) No money is exchanged since Kelly is able to keep playing rock music in the
common area.
b) No money is exchanged since Jennifer is able to keep the peace and quiet in the

10/11/18 Page 2 of 6
 common area.
c) Jennifer pays Kelly at least Php950 (but no more than Php1000) to stop listening
to rock music.
d) Kelly pays Jennifer at least Php950 (but no more than Php1000) to listen and
play rock music in the common area.

Question 3 [10 points, 10% each answer]

Multiple Choice.
1. One way to overcome the Tragedy of the Commons is to
a. leave the market alone because the market will reach an equilibrium in which the efficient
amount of the resource is used
b. take away property rights so that no one owns the resource
c. assign property rights so that someone owns the resource
d. none of the above

2. In drilling a new oil well in an existing oil field, the fact that output on existing wells is reduced
means that
a. existing wells have negatively sloped demand curves
b. existing and new wells are owned by different people
c. existing and new wells are owned by the same people
d. there is discrepancy between private and social costs

3. Public goods tend to be

a. underprovided by the private market because of the free-rider problem
b. underprovided by the private market because the marginal benefits of consumption are too
low
c. overprovided by the private market because of the tragedy of the commons
d. underprovided by the private market because the marginal cost of production is too high

4. Each of the following provides incentives to reduce a negative externality except

a. a merger with affected firms
b. subsidizing consumption of the good being produced
c. bargain among firms
d. taxation of the externality

5. The government is considering the imposition of an excise tax on cigarettes with the rationale of
reducing the negative externalities of cigarette smoking. Ideally, the size of the excise tax should
be
a. equal to the private cost
b. equal to the sum of the social and private costs
c. equal to the excess of the social cost over the private cost
d. equal to the excess of the private cost over the social cost

6. If the social cost of producing chickens is greater than the private cost, then we can be sure that
a. a positive externality exists

10/11/18 Page 3 of 6
 b. chicken is healthful and more should be produced
c. a negative externality exists
d. the price of chicken is too low
e. chicken productions should be subsidized

7. Private negotiations along the lines suggested by the Coase Theorem are best suited to resolve
conflicts that affect
a. a large number of widely dispersed households
b. only a small number of individuals
c. only those who create positive externalities
d. only those who create negative externalities
e. the provision of near-public goods but not pure public goods

8. The Coase Theorem has problems because

a. generally, bargaining costs are not zero
b. individuals are not concerned with others.
c. markets always exist
d. all of the above

9. Assume that the production of electricity results to the emission of toxic wastes in the
environment – which of the following statements is incorrect?
a. the market price of electricity is lower than the socially optimal price of electricity
b. the level of output of electricity is above the socially optimal level of output
c. the externality can be corrected through taxation of the producer
d. none of the above

10. Market equilibrium is

a. inefficient only if we have negative externalities present
b. efficient only if we have positive externalities present
c. inefficient if we have either negative or positive externalities present
d. always efficient, regardless of the nature of externalities

Question 4 [5 points, 10% each answer]

True or False.
1. A positive externality is an external benefit that accrues to the buyers in a market while a
negative externality is an external cost that accrues to the sellers in a market. False.
2. A market that generates a negative externality that has been internalized generates an
equilibrium quantity that is more than the optimal quantity. False.
3. According to the Coase theorem, an externality always requires government intervention in order
to internalize the externality. False.
4. To reduce pollution by some targeted amount, it is most efficient if each firm that pollutes
reduces its pollution by an equal amount. False.
5. A tax always makes a market less efficient. False.
6. A regulator can always achieve the same level of pollution with either a corrective tax or by
allocating tradable pollution permits. False

10/11/18 Page 4 of 6
 7. If Bob values smoking in a restaurant at PhP100 and Sue values clean air while she eats at
PhP150, according to the Coase theorem, Bob will not smoke in the restaurant only if Sue owns
the right to clean air. False.
8. An advantage of using tradable pollution permits to reduce pollution is that the regulator need
not know anything about the supply for pollution rights. False.
9. If transaction costs exceed the potential gains from an agreement between affected parties to an
externality, there will be no private solution to the externality. True.
10. A corrective tax sets the quantity of pollution while tradable pollution permits set the price of
pollution. False.

Question 5 [4 points, 50% each answer]

Suppose we have two firms, A & B, who leak toxic wastes into the river. The government wants to reduce
the total toxic wastes leaked into the river by 50% by issuing tradeable permits. Initially, total gallons of
toxic wastes produced by A & B that goes into the river is 120 (60 each firm).

The abatement cost of Firm A is Php160 per gallon of toxic waste while for Firm B, abatement cost is
Php100. The tradeable permit is sold at Php130. The government allocates the tradeable permits equally
to firms A & B.

1. If Firm B sells 15 units of its tradeable permits to Firm A, what is the total cost of achieving the
goal (reducing the toxic wastes by 50%)?

Firm B leaks a total of 60 gallons of toxic wastes.

- uses 15 units of tradeable permits -> leaks 15 gallons of toxic wastes
- sells 15 units of tradeable permits -> gains Php1,950 (Php130x15)
- needs to reduce 45 gallons of toxic wastes -> total abatement cost is Php4,500 (Php100x45)
Net cost to Firm B is Php4,500- Php1,950=Php2,550

Firm A leaks a total of 60 gallons of toxic wastes.

- buys 15 units of tradeable permits -> pays Php1,950
- uses 30 + 15 units of tradeable permits -> leaks 45 gallons of toxic wastes
- needs to reduce 15 gallons of toxic wastes -> total abatement cost is Php2,400 (Php160x15)
Total cost to Firm A is Php2,400 + Php1950 =Php4,350

Total cost of achieving the goal is Php4,350 + Php2,550= Php6,900.

2. Instead of reducing toxic wastes by 50% via tradeable permits, the government uses regulation by
forcing each firm to reduce their toxic wastes to 30 gallons each. What is the total cost of
achieving the goal?

Firm B leaks a total of 60 gallons of toxic wastes.

- needs to reduce 30 gallons of toxic wastes -> Php3,000 (Php100x30)
Total cost to Firm B is Php3,000.

Firm A leaks a total of 60 gallons of toxic wastes.

10/11/18 Page 5 of 6
 - needs to reduce 30 gallons of toxic wastes -> Php3,000 (Php160x30)
Total cost to Firm A is Php4,800.

Total cost of achieving the goal is Php3,000 + Php4,800= Php7,800.

10/11/18 Page 6 of 6