Prof. Bryan Caplan

http://www.bcaplan.com

Econ 370

HW#3 (please type; diagrams may be drawn by hand)

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 Q^m and the efficient quantity Q^e. 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).

V. [Use your calculator for this one!] In 1950, suppose that Britain has a per-capita GDP of $8000, and Hong Kong has a per-capita GDP of $400. If Britain's per-capita GDP grows at 1% per year, and Hong Kong's grows at 8% per year, what will living standards look like in 1960? 1970? 2000? Approximately when will Hong Kong's living standard exceed Britain's? How does this illustrate the importance of dynamic efficiency?

Year British GDP Hong Kong GDP

1950 8000 400

1960 8837 863

1970 9762 1864

2000 13,157 18,761

Hong Kong's GDP equals Britain's in approximately 1994. This shows that if a poor society is more dynamically efficient than a rich one, it will eventually overtake the richer country. It also shows that with a high rate of growth, even a poor country can get rich quickly.

VI. Suppose there is a constant marginal cost of producing CDs of $2.

A. What will be the price of CDs if anyone can produce them? What will the payoff to the artist be in this case?

The price will be $2; the artist gets nothing.

B. If the artist's copyright is enforced, he will be able to earn $5 per CD. How many copies must be demanded at this price if the artist is willing compose for a minimum fee of $30,000?

At least $10,000 copies must be demanded, since the artist will get a $3 royalty on each copy.

C. Suppose you are a wealthy patron of the arts who wishes to make music available to all. The artist holding the copyright can earn $30,000. How large of a prize must you offer the artist to persuade him to put his music into the public domain (so it can be copied free of charge by anyone)? What will happen to the price of the artist's CD?

You merely need to pay the artist a prize of $30,001. Then the CD will be produced and will sell for $2.

VII. What provides the most important incentive to innovate in each of the following cases? If it isn't patent or copyright, what exactly is it? [These are just my guesses, although some guesses are better than others.]

A. Personal webpages.

Fame.

B. Yahoo!

First-mover advantage (they got a reputation early on, so everyone knows about them).

C. New drugs for fighting AIDS.

Patents play a big role; fame could also be important.

D. John Grisham novels.

Copyright.

E. Today's Washington Post.

Imitation difficulties: it would take more than a day to copy and distribute today's newspapers.

VIII. Draw AC and demand curves for:

A. A zoo in Fairfax.

The demand curve should fall below the AC curve (there aren't any zoos here, are there?)

B. Groceries within walking distance of Fairfax.

Groceries within walking distance of Fairfax. The demand curve should cut the AC curve at a somewhat high price; you have to pay more to shop at the neighborhood Safeway.