I. Contrast the private and social benefits of each of the following (2-3 sentences each). If you think the private and social benefits are approximately equal, explain why.
A. You go to a movie.
The private benefit is your enjoyment of the movie. The private and social benefits are probably about equal, though your movie viewing might provide some small informational benefits to your friends and other people you talk to about movies.
B. You mow your lawn (think aesthetics).
The private benefit is that you have a nice-looking lawn; but there are additional social benefits of a "nice neighborhood" that spill over to your neighbors.
C. You take the Metro instead of driving during rush hour.
The private benefit to you is just the ride; but there are additional social benefits from the reduction of road congestion during rush hour.
D. You learn how to program computers.
The private benefit is the additional income you can earn because you required this new skill; since customers or employers have to pay you the market value of your work, however, there are probably no additional social benefits.
E. You invent a cure for AIDS.
The private benefit is whatever income you can make from selling the drug. But there are probably a lot of additional social benefits - at minimum, from "piracy" of your idea.
II. Contrast the private and social costs of each of the following (2-3 sentences each). If you think the private and social costs are approximately equal, explain why.
A. You start smoking marijuana.
The private costs are the money you have to spend on the marijuana, the time you spend smoking, extra health risks, etc. There would probably be some additional social costs - your parents for example might be willing to pay a large amount to have you not smoke.
B. You mow your lawn (think noise).
The private cost is your time, fuel, etc. But there are additional social costs because the lawnmower's noise probably irritates your neighbors somewhat.
C. You drive late at night instead of taking the Metro.
The private cost is the fuel and wear-and-tear on your car. There are probably no additional social costs, because late at night traffic congestion wouldn't be a problem anyway.
D. You put up a web page attacking organized religion.
The private costs are your time, web server fees, and so on. The social costs are the misery you inflict on believers who find your webpage offensive.
E. You rob a bank.
The private costs are your time, expense of having a getaway car, gun, mask, and so on. The social costs are the security measures banks take to foil your plans (guards, vaults, cameras), the fear of tellers and customers when you pull out your gun, and so on.
III. Assume that national defense is a public good in the strong sense - an unsubsidized market produces NO defense even though the social benefits of it are high. Carefully graph this market, showing the market quantity Qm and the efficient quantity Qe. Shade the region of deadweight losses, and intuitively explain why these deadweight losses are so large. (1-2 sentences)
The entire region between the D and S curves is deadweight loss. These deadweight losses are so large because a vital product - the absence of which may lead to wide scale deaths at the hands of a conquering enemy - simply does not exist.
IV. "Immigrants impose externalities on American workers by reducing wages." Carefully explain why this claim mis-uses the notion of externalities. (3-4 sentences)
All that is happening is that the S curve for labor shifts to the right; there aren't any negative side effects that the market isn't taking into account. American workers are worse off if wages fall, but American employers are better off by the same amount. If immigrants drive down wages by $1/hour, American workers get $1/hour less in surplus, but American employers get $1/hour in surplus more. On balance, then, there are no negative side effects when immigrants drag wages down. (Alternately, you could also say that the negative externality imposed on workers is exactly balanced by the positive externality on employers).
[Use your calculator for this one!] In 1950, suppose that
Year British GDP Hong Kong GDP
1950 8000 400
1960 8837 863
1970 9762 1864
2000 13,157 18,761
VI. Suppose there is a constant marginal cost of producing CDs of $2.
You merely need to pay the artist a prize of $30,001. Then the CD will be produced and will sell for $2.