Question

1. Determining market and socially efficient quantity

For this question, please refer to the following graph. It may help to print this out so you can draw on it: https://drive.google.com/file/d/0B-gQ84rVpHz_aEVMOFpvamcxUzg/view?usp=sharing

Suppose there is a positive externality of $6 for each unit of widget in the market depicted in the diagram. The free market equilibrium quantity is _________ and the socially efficient quantity (the quantity that society wants to be at) is _____________.

6, 6

3, 6

3, 3

3, 0

6, 3

2. Total surplus without government intervention

For this question, please refer to the following graph. It may help to print this out so you can draw on it: https://drive.google.com/file/d/0B-gQ84rVpHz_aEVMOFpvamcxUzg/view?usp=sharing

Suppose that there is no government intervention. What is the total surplus in the free market, including the total positive externality in the market?

$27

$15

$72

$42

$45

3. How to maximize total surplus when there is a positive externality?

For this question, please refer to the following graph. It may help to print this out so you can draw on it: https://drive.google.com/file/d/0B-gQ84rVpHz_aEVMOFpvamcxUzg/view?usp=sharing

Is the total surplus maximized in the market with a $6 positive externality when there is no government intervention? If not, how can it be maximized?

Yes, the total surplus in that market is maximized when there is no government intervention.

No, the government can impose a tax of $2 to maximize total surplus.

No, the government can impose a subsidy of $6 to maximize total surplus.

No, the government can impose a tax of $6 to maximize total surplus.

No, the government can impose a subsidy of $2 to maximize total surplus.

4. How total surplus changes with a government policy

For this question, please refer to the following graph. It may help to print this out so you can draw on it: https://drive.google.com/file/d/0B-gQ84rVpHz_aEVMOFpvamcxUzg/view?usp=sharing

Suppose the government imposes a subsidy of $4 to the market with a $6 positive externality (it's okay if this is not the most efficient policy). What is the gain in total surplus when this policy is used?

+$4

-$4

+$12

+$8

+$0

Answer 1

Answer 1:

3,6.

The free market equilibrium occurs at the point where marginal benefit curve intersects the supply curve or the cost curve. Socially efficient quantity occurs at the point where social benefit curve intersects the cost curve.

Answer 2:

Total surplus in the market without government intervention = area triangle ABC + area triangle BCD = $15 including positive externality.

Answer 3:

No, total surplus is not maximized in this case. Government should impose a subsidy of $6 to maximize total surplus in the economy.

Answer 4:

Option A. +$4.

Thus, increase in total surplus when government imposes subsidy in the market = +$4.