Project #96407 - Micro Economic

Name _____________________ Economics 101 Fall 2015 Instructor: Mario Muzzi Problem Set #4 – Due 11/30/15 1) (7pts) Externalities: a) (1pt) What type of externality does the graph below represent? b) (4pts) Using the letters provided calculate social welfare under the market outcome and the socially optimal outcome. c) (2pts) Describe in words and show the deadweight loss. 2) (10pts) Public Goods: Categorize whether the following goods are private goods, public goods, common resources or a natural monopoly and explain why. a) The Golden Gate Bridge b) Golden Gate Park on a Tuesday afternoon. c) The air you breathe. d) A chicken. e) Netflix movies 3) (8pts) Public Choice: Suppose you are a college student registered to vote in California. The Republican gubernatorial candidate has made the following campaign pledge: “My fellow Californians, if I am re-elected Governor I will make education my top priority. To show you that I mean business, I will support a bill that gives all college students a $10,000 credit towards tuition” In response, the Democratic Candidate proposes the following: “My fellow Californians, I will not be out done by my counterpart. I propose a $30,000 tuition credit for all college students.” Assume for simplicity that the tuition credit bill will be passed into law immediately after the elections and students will receive the money soon thereafter. Also assume that you see no difference between Republican and the Democrat except for their tuition credit proposals. Finally, assume that you are a hard working student with a part-time job that pays $16/hr. a) (2 pts) If California has 1 million registered voters and in order to vote you will be forced to miss ½ hour of work, is it rational to vote? (show your work) b) (2 pts) What if the Democrat proposes a tuition credit of $120,000? Would that make it rational to vote? (show work) c) (2pts) Now imagine that the Republican and the Democrat were running for Mayor in a small town of only 100 voters including yourself. Instead of tuition credit, they are offering tax cuts. The Republican’s proposal will cut your taxes by $2,500 and Democrat’s proposal will reduce your taxes only by $500. Again assume that all you care about is your taxes and that you have to take ½ hour from your work to vote. Is it rational to vote? d) (2pts) Based upon the answers above, is it more rational to vote in statewide elections or local elections? 4) (8pts) Adverse Selection: Consider a state in which automobile drivers are divided equally into two types of drivers: careful and reckless. The average annual auto insurance claim is $400 for a careful driver and $1,200 for a reckless driver. Suppose the state adopts an insurance system under which all drivers are placed in a common pool and allocated to insurance companies randomly. An insurance company cannot refuse coverage to any driver. By law, each insurance company must charge the same price. Assume the price charged by the insurance companies is the break-even price. Predict the price of auto insurance if: (2pts) Auto insurance is mandatory for all drivers. (Show your work) (2pts) Auto insurance is voluntary for all drivers? (Show your work.) (2pts) Define adverse selection and explain how it applies to this situation. (2pts) Under a voluntary insurance system, how can the adverse selection problem be eliminated or reduced? 5) (10 pts) Moral Hazard: FMC, Inc makes heavy-duty conveyor belts for airports throughout the world. Brad works as a salesman for FMC. FMC pays Brad a monthly base salary. In addition, Brad receives a commission based on his sales performance during the month. If he sells 3 conveyor belts he receives a $1,000 commission payment. If he sells 2 conveyor belts he receives a $200 commission payment. But if he only sells one, he does not receive any commission. Since FMC does not supervise Brad’s work activity during the month, Brad can choose to either give a strong effort or a weak effort. Brad faces four possible outcomes: i) If Brad is lucky and puts forth a strong work effort, he will sell 3 conveyor belts in one month and will be paid a $1,000 commission. ii) If Brad is unlucky and puts forth a strong work effort, he will sell 2 conveyor belts in one month and will be paid a $200 commission. iii) If Brad is lucky and puts forth a weak work effort, he will sell 2 conveyor belts in one month. and will be paid a $200 commission. iv) If Brad is unlucky and puts forth a weak work effort, he will sell 1 conveyor belt in one month. and will be no commission. The cost associated with giving a strong effort (e.g. stress and sweat) during the entire month is $400, while a weak effort costs $0. Assume that 50% of the time Brad will experience good luck and the other 50% he will experience bad luck. (3pts) By calculating Brad’s expected return indicate whether Brad will put forth a strong effort or a weak effort. (3pts) Now suppose FMC pays Brad only $700 if Brad sells 3 conveyor belts. Will Brad put forth a strong effort or a weak effort? (show your work) (2pts) Define Moral Hazard and explain how it applies to Brad’s situation in (b). (2pts) How can FMC eliminate Brad’s Moral Hazard problem? 6) (7pts) Coase Theorem: Read the article I posted on Blackboard regarding tradable gasoline rights (TGR) and answer the following questions: a) (1pt) What type of externality is the TGR intended to address? b) (3pts) In half of a page, describe how the TGR system would function. c) (3pts) In half of a page, describe why the TGR system is superior to the government imposing gas standards on producers or gas taxes on consumers.

Subject Business
Due By (Pacific Time) 11/28/2015 10:59 pm
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