Question

(1) The argument that society should be in favor of changes that benefit some people without making others worse off is known as _____.

(a) the Pareto principle

(b) a positive externality

(c) the Coase Theorem

(d) the cost-benefit principle

(2) One way a government can eliminate a market failure _____.

(a) is to regulate the price so that it equals marginal cost

(b) is to implement a price floor equal to marginal cost

(c) is to regulate the price so that it is below average cost

(d) None of the above solutions will eliminate a market failure

(3) The demand for paper is given by Q_D = 200 – 2p and the supply by Q_S = 3p. The negative externality associated with pollution by the paper mills is $10 per unit of paper. In an unregulated market for paper, the deadweight loss associated with the externality is _____.

(a) 0

(b) 60

(c) 100

(d) 120

Answer 1

1) This is called the Pareto principle where any such allocation that results in improving the welfare of at least one individual without reducing the welfare of others, is considered a Pareto improvement

2) There are two ways of regulating the market to prevent market failure, using marginal cost pricing (so that price equals the marginal cost) or using average cost pricing (so that price equals the average cost)

3) Market equilibrium price and quantity

200 – 2p = 3p or p = 200/5 = 40 and q = 3*40 = 120.

Social equilibrium price and quantity

200 – 2p = 3(p – 10) or p = 230/5 = 46 and q =108.

DWL = 0.5*10*(120 – 108) = 60

Hence deadweight loss is 60