EXERCISE 16: Public Goods, Externalities, Tax Incidence
J. Wahl – Micro Principles
1. Explain how to obtain a market demand curve for a PUBLIC good. How does this
process differ from obtaining a market demand curve for a PRIVATE good?
2. Suppose a factory and ten laundries operate in close proximity. The factory emits
smoke, which causes extra costs for the laundries to the tune of $6000 per year. The factory
could put in a new smokestack effectively costing $5000 per year to erect and maintain.
Alternatively, each laundry could install a special dryer that costs $400 per year to put in place
and run.
What is the efficient solution to this negative externality?
If all parties know that the laundries have no legal remedies, what will happen?
If all parties discover that the law has changed and the laundries can now go to court and recover
damages from the factory, what will happen? (I know this is extreme, but assume no costs
associated with litigation – we will talk about the consequences of relaxing this assumption in
class.)
Now suppose, instead of a legal change favoring laundries, the EPA passes a mandate requiring
new smokestacks on factories, what will happen?
3. Now suppose that a new improved smokestack has been developed that costs $3750 per year.
Suppose further that, for laundries to get together and determine a collective course of action,
EACH laundry incurs a cost of $30 per year (for lost time, renting a conference room, and so
forth). Laundries do NOT incur this cost if they pursue individual actions (like each buying its
own dryer).
What is the efficient solution to this negative externality?
If all parties know that the laundries have no legal remedies, what will happen?
If all parties discover that the laundries could go to court and recover damages from the factory,
what will happen? (Again, assume no costs associated with litigation per se…)
Now suppose, instead of a legal change favoring laundries, the agency passes a mandate requiring
new smokestacks. Regrettably, the EPA is a little behind the times, technologically speaking,
and the agency is only aware of the old technology associated with the $5000 smokestack.
What will happen?
4. Suppose the demand curve for hot dogs is qd = 20-2pd and the supply curve is qs = 5+3ps.
What are the equilibrium quantity and price of dogs? If dog buyers must pay a tax of $1 per dog
to a govt. official posted by the hotdog stand, what is the equilibrium quantity of dogs? The price
demanders pay? The price received by suppliers?
5. Suppose, with the same demand and supply curves for hot dogs, the government now
requires the dog SELLER to hand over $1 per dog. What are the equilibrium quantity, demand
price, and supply price of dogs in this scenario?
