Question 1

Consider a monopolist with a private MC of $20 per unit who faces a demand curve of P = 100 - q.There is also a negative consumption externality in the market of $40 per unit.What is the DWL in the market outcome?

A)DWL = $800
B)DWL = $1600
C)DWL = $200
D)DWL = $400
E)DWL = $0

DWL = $0

Accepted Answer

DWL = $0

Question 2

Consider a monopolist with a private MC of $20 per unit who faces a demand curve of P = 100 - q.There is also a negative consumption externality in the market of $40 per unit.The government successively introduces competition into the supply side of the market, so now instead of a monopolist there are many price-taking firms.Which statement is true?

A)The government intervention increases the DWL in the market from 0 to $800.
B)The government intervention in the market decreases the DWL from $800 to $0.
C)The government intervention reduces but does not eliminate DWL in the market.
D)The government intervention increases DWL from $0 to $1600.
E)None of the above.

Accepted Answer

The government intervention increases the DWL in the market from 0 to $800.

Question 3

The Theory of Second Best suggests:&#10;A)The government should only remove small market failures in the economy.&#10;B)The government should never attempt to remove market failures in the economy.&#10;C)Some market failures can help offset other market failures, increasing overall welfare.&#10;D)All of the above.&#10;E)None of the above.

Accepted Answer

The Theory of Second Best posits that in situations where one market failure cannot be fully corrected, allowing another market failure to persist can sometimes help to mitigate the negative effects of the first, potentially leading to an increase in overall welfare. This theory challenges the notion that fixing all market failures is always the best approach.

Question 4

Consider a monopolist with a private MC of $20 per unit who faces a demand curve of P = 100 - q.There is also a negative consumption externality in the market of $40 per unit.What is the most appropriate policy response if the government wishes to maximize surplus in the market.

A)The government should implement a Pigovian tax of $40 on consumers.
B)The government should implement a Pigovian tax of $40 levied on the monopolist.
C)The government should subsidize production by $40 per unit.
D)Either a or B

Accepted Answer

The most appropriate policy response if the government wishes to maximize surplus in the market, given the presence of a negative consumption externality of $40 per unit, would be to implement a Pigovian tax. A Pigovian tax is a tax imposed on a market activity that is generating negative externalities, with the tax intended to correct an inefficient market outcome by being set equal to the social cost of the negative externalities.

Question 5

A lesson to policy makers from the Theory of Second Best is that:&#10;A)Care is needed removing any one distortion in the economy, given the possible interaction between various distortions in the economy.&#10;B)Total surplus will increase if all distortions can be simultaneously eliminated.&#10;C)The largest market failures need to removed first.&#10;D)a and B

Accepted Answer

The Theory of Second Best suggests that removing a single distortion in the presence of other distortions may not lead to an improvement in economic efficiency, and that total surplus can increase if all distortions are eliminated simultaneously. This highlights the complexity of economic systems and the need for careful policy analysis.

Deck 18: The Theory of Second Best