Question

1.     Consider the market for the good: Michael’s Secret Stuff Sports Drink. Draw a basic supply and demand model for the good.

2.     It was found that there is a positive externality from the consumption of Michael’s Secret Stuff Sports Drink is that the consumers and the by-standers have better fitness.

a.      Should the government apply a tax or a subsidy to increase societal gains from the consumption of this good?

b.     Draw a supply and demand model that reflects your suggestion in 2.a.

c.      Discuss the differences between private value and social value.

d.     Discuss changes in consumer surplus, producer surplus, and deadweight loss based on the action in your model.

e.      How might the impact of your answer in 2.a. be affected if the demand for Michael’s Secret Stuff Sports Drink were Inelastic? What if demand were Elastic? Draw graphs to aid your discussion.

Answer 1

1. diagram is below

2.

a) govt should provide subsidy as it will eliminate the under provision or under production of good.

b) below is the diagram

c) private value is value accruing to owner to business while social value is value accruing to society ie it includes private value and amount of externality.

d) consumer surplus will fall (part of it will transferred to producer), producer surplus will rise( due to optimum

production) and deadweight loss will be eliminated