ECON 1001

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ECON 1001

• Tutorial 11

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• Q1) Which factor, if it were present, would
  lessen the ability of the Coase Theorem to solve
  an externality?
• The situation is already efficient.
• Negotiating requires hiring a lawyer.
• The parties are all self-interested.
• The potential gain in surplus is high.
• Property rights have already been assigned to one
  of the parties.
• Ans B

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• Coase Theorem states that without any transaction
  costs, any allocation of property rights would be
  efficient because externalities will be traded
  privately among economic agents.
• Hiring a lawyer is a kind of transaction costs
  one has to spend time to find a lawyer, as well
  as paying the lawyer to do the negotiation. In
  other words, in order to exercise ones right,
  the person has to incur some transaction costs.
• Therefore, Option B is the answer.

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• Q2) If the cigar smoker paid each other occupant
  0.50 for the right to smoke, the cigar smoker
  would be ? and the other occupants would be
  ? .
• Better off worse off.
• Better off just as well off as before the
  payment.
• Better off better off.
• Just as well off as before the payment better
  off.
• Worse off just as well off as before the
  payment.
• Ans B

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• According to the story
• The smokers reservation price for smoking is 5.
• Each of other occupants reservation price for
  clean air is 0.50. ( instead of having clear
  air, they agree to be paid 0.50 to endure smoky
  air)
• Now the smoker is paying to compensate the other
  occupants from the smoky air.

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• There are 9 other occupants. Each of them is
  paid 0.50, which is their reservation price.
• Before the payment, they were enjoying clean air
  which was valued also at 0.50 (but not actually
  pocketing 0.50 when air was clean).
• Therefore, they are equally well off as before
  the payment.

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• The smokers reservation price for a drag is 5.
• He is paying 0.50 x 9 to smoke, which amounts to
  4.50.
• There is a 0.50 surplus.
• Hence, he is better off.

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• Q3) Suppose Paul has offered to pay Sid 3500
  per month to cease development. If Sid accepts
  Pauls offer, it would
• Make Paul worse off and Sid better off.
• Make both Paul and Sid better off.
• Make both Paul and Sid worse off.
• Generate deadweight loss.
• Make Paul better off and Sid worse off.
• Ans B

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• According to the story,
• Paul values his view at 5000.
• Sid could have earned 10000 with his
  development.
• Sids SECOND BEST alternative earns him 7000.

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• As Paul is paying Sid a price less than his
  valuation for a clear view, (5000-3500), he is
  enjoying some surplus, and hence is better off.
• As Sid is paid 3500 not to develop the land, he
  can then pocket this money, and carry out his
  SECOND BEST plan, which makes him 7000.
• In total, Sid will be earning 10500 in cash,
  hence he is better off as well.

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• Q4) The least costly solution to the external
  cost is for
• Curly to endure Moes snoring.
• Both to live alone.
• Moe to eliminate his snoring.
• Moe to find a fellow snorer to live with.
• Moe to pay Curly for his discomfort.
• Ans C

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• According to the background information
• One-bedroom flat is 500/month.
• Two-bedroom flat is 800/month.
• Moe has a seriously snoring problem.
• Curly values a good nights sleep at 150/month.
• Snore-eliminating device costs 50/month.

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• There are 3 possible ways for Curly and Moe to
  arrange for their accommodation.
• Each rents a 1-bedroom flat, costing them
  1000/month in total.
• Curly and Moe share a 2-bedroom flat while Curly
  cannot sleep well. This costs them 950/month in
  total (800 150).
• Curly and Moe share a 2-bedroom flat. Moe uses a
  snore-eliminating device, costing them in total
  850/month (800 50).

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• Of the 3 feasible ways, the 3rd costs them the
  least.
• Therefore, the two should become housemates.
• And, at the same time, Moe should use the device
  to eliminate his loud snoring.

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• Q5) Assume that Curly and Moe choose to divide
  the change in surplus from living together
  equally, and apply it to their monthly rent
  payments. As a result, Moe will pay ? /month
  in rent, and Curly will pay ? /month in rent.
• 425 425.
• 400 400.
• 350 450.
• 375 425.
• Neither amount can be determined.
• Ans D

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• Calculating the surplus from living together
• If Curly and Moe each rents a 1-bedroom flat,
  they have to pay 1000/month in total.
• Now, the rent for a 2-bedroom flat is just
  800/month, so they have saved 200 in total.
• However, in order to live together in harmony, a
  snore-eliminating device has to be bought.
• Therefore, the total surplus they have together
  is 150 (1000 800 50).

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• Curlys maximum willingness to pay for rent in a
  shared 2-bedroom flat is 500 - 75 425.
  (500-150/2)
• Because Moe has no problem with his own snoring,
  his maximum willingness to pay will be 375.
  (500-150/2-50).
• And so, (D) is the correct answer.

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• Q6) If the highway is viewed as having a zero
  price, one can predict that ? drivers will
  be on the road between 8am and 9am.
• 500
• 400
• 300
• 200
• 100
• Ans A

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• Let us look at the table to determine the answer.
• Marginal Benefit can be viewed as the maximum
  amount of money the last driver in the congestion
  is willing to pay instead of getting stuck in the
  traffic.

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• If the highway can be used free of charge, anyone
  with a MBgt0 would choose to use that road.
• Therefore, 500 drivers will be using the highway,
  and it is expected that everyone has to spend
  about 260 minutes to get through the traffic.

0
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• Q7) Suppose a toll is imposed between 8am and 9am
  and the price is 5 per driver. One can predict
  that ? drivers will be on the road between
  8am and 9am.
• 100
• 200
• 300
• 400
• 500
• Ans B

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• Again, let us look at the table to determine the
  answer.
• With a road toll of 5, only drivers who have
  MBgt5 will use the highway.
• There are 200 drivers valuing using the highway
  at more than 5, and so that is the answer.

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• Q8) The reason drivers would prefer building new
  roads to a 5 toll to reduce commute times is
  because
• Building roads is the only solution.
• They know a toll would not alter commuting
  behaviour.
• Cities always need new roads.
• The cost of new roads falls on all taxpayers the
  toll only falls on those who use the existing
  road.
• Of the commitment problem.
• Ans D

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• Options A and B are not right. We know that by
  setting a toll, the congestion on the highway can
  be reduced (and solved entirely).
• Option C does not make any economic sense at all.
• Option E is also not right, as we are not talking
  about competition or game theory.

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• If a toll of 5 is imposed, users of the highway
  will have to pay money out from their pocket on a
  pay as you use basis.
• Which means the users will have to pay for what
  they use.
• This is not a problem until rational consumers
  realise that they can actually shift the
  financial burden to other people, spreading the
  contribution among all people in the city.

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• By having the government building more roads, all
  taxpayers in the cities are financing the
  project.
• Probably not all taxpayers are users of that
  highway anyway.
• Frequent highway users will find out that instead
  of paying 5 every single day, commuting on other
  peoples money (including theirs, but the cost is
  spread) is a bargain.
• And hence, Option D is the answer.

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• Q9) Relative to driving an average car, driving a
  larger-than-average car generates ? And
  driving a smaller-than-average car generates ?
  .
• An external cost an external benefit.
• An external benefit an external cost
• An external cost neither an external benefit nor
  an external cost.
• An external cost an external cost
• Neither an external cost nor an external benefit
  an external benefit.
• Ans A

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• According to the story
• Smaller cars sustain more damage in an accident.
• Smaller cars generate less air pollution on
  average.
• Every person in the economy drives at least one
  car.

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• That implies larger cars
• Are imposing more danger on the road to all road
  users.
• Are generating more air pollution on average.
• And hence, driving larger cars generates an
  external cost to the economy.

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• Note that the question stated relative to
  driving an average car, which means we have to
  compare with driving an average car.
• Even though any kind of driving generates air
  pollution to the economy, we have to compare
  driving a smaller car with an average car.

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• Comparing to an average car, a smaller car
  generates less air pollution on average.
• Therefore, driving a smaller car is actually
  pulling down the average air pollution in the
  economy.
• Therefore, external benefit is generated in this
  sense.

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• Q10) As the average size of cars increase, the
  incentive to buy a smaller car
• Also increases due to cost savings at the fuel
  pump.
• Also increases to offset the external cost of air
  pollution.
• Decreases because of the increased risk of injury
  in an accident.
• Remains the same because car purchases depend on
  individual preferences.
• Decreases because automakers will have to charge
  a higher price for them.
• Ans C

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• According to the story, smaller cars are more
  accident-prone.
• As the average size of cars in the economy
  increases, the road become more dangerous out
  there for smaller cars.
• As smaller cars tend to sustain the most damage
  in accidents, the incentive to buy smaller cars
  decreases because of the reason stated in Option
  C.