Question

There is a town in North Ontario called “Behind The Stars,” where individuals care about “dream comfort memories,” a public good. Suppose the marginal costs of “dream comfort memories” (q) are MC = 10. The marginal benefits and average benefits are MB = 90 ≠ 4q and AB = 90 ≠ 2q, respectively.

(a) If the town is interested in providing the socially optimal amount of “dream comfort memories,” what are the resulting net benefits?

(b) Unfortunately, “dream comfort memories” are a public good and it is impossible to prevent people from over exploiting them, i.e. the town is left “helpless” against its own preferences to be in a more-or-less permanent dream-like trance. What are the resulting net benefits?

(c) Compare (a) and (b). What can be said about the role of governments in an economic context?

Answer 1

a. To calculate net benefits, equate average benefits to marginal costs.

Or  .

b. The resulting net benefits can be calculated by equating marginal benefits to marginal cost.

Or  

c. We see that over-exploitation of resources reduces the optimal amount of good available to each person. The government can intervene in such a situation and ration resources to increase the social optimum and hence, welfare.