Cost Per Unit of Output

Question three:

1. What is the          external cost per unit of output?

Social cost is equal to private cost plus external cost, in this case we are given private and social costs and therefore we can derive external costs as follows:

Quantity

Private Cost

Social Cost

external costs

1

\$2

\$4

1/10

Cost Per Unit of Output

\$2

2

\$6

\$10

\$4

3

\$12

\$18

\$6

4

\$20

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Cost Per Unit of Output

\$28

\$8

5

\$30

\$40

\$10

What level of      output will be produced?

Production will be at the point that maximizes profits; this point will be where marginal cost equal marginal revenue, marginal cost in this case will be the marginal private cost, and marginal benefits will be marginal revenue, the following table summarizes the values:

Quantity

3/10

Cost Per Unit of Output

Private Cost

Social Cost

Benefit

external costs

marginal private cost

marginal benefits

1

\$2

\$4

\$12

\$2

\$2

4/10

Cost Per Unit of Output

\$12

2

\$6

\$10

\$22

\$4

\$4

\$10

3

\$12

\$18

5/10

Cost Per Unit of Output

\$30

\$6

\$6

\$8

4

\$20

\$28

\$36

\$8

\$8

\$6

6/10

Cost Per Unit of Output

5

\$30

\$40

\$40

\$10

\$10

\$4

The chart below sumarises the values

Therefore production will be 3.5 units

1. What level of          output should be produced to achieve economic efficiency?

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Cost Per Unit of Output

We introduce the marginal social costs into the chart and the point where marginal cost curve is equal to marginal benefits is the economic efficient production point, the chart below shows the marginal curves:

Therefore the economic efficient point of production is 3 units.

d. What is the value of society of correcting the externality?

To correct externalities the production level will decline from 3.5 to 3 units, therefore the society will produce less by 0.5 units, this is the level that the society has to pay to correct externalities and therefore pay for the extra costs not incurred.

Question # 4 – What level of tax would be appropriate to internalize the externality in exercise 3?

Private cost should be equal to social cost, the current production level is 3.5 units

The private cost is \$15, the social cost at this point is \$22.5, the external cost here will be

8/10

Cost Per Unit of Output

equal to 22.5 – 15 = \$7.5, the best tax rate should be 7.5/15 X 100 = 50%, therefore a 50% tax will make social cost to be equal to private cost.

Question # 5 – If, in exercise 3, the Private Cost and Social Cost columns were reversed, you would have an example of what? Would too much or too little of the good be produced? How would the market failure be resolved, by a tax or by a subsidy?

If we reverse the private cost and the social costs we will have positive externalities, this is where the social costs will be lower than the private costs, for this reason therefore to resolve this market failure there will be a need to subsidies production in order to produce more to benefit from positive externalities, In this case too little of the good will be produced therefore a subsidy will be used to improve on the market failure.

Chapter 15 Questions

Question # 6 – Suppose the resource price rises from \$10 to \$12 to \$14 to \$18 to \$20 as resource units go from 1 to 5.

Question # 7 – In question 6, calculates the transfer earnings and economic rent of the third unit of the resource when four units of the resource are employed. Do the same calculations when only three units of the resource are employed. How do you account for the different answers?

When 4 units are employed it is required that \$40 are payed for the resources, however the amount paid is 18 X 4 = 72, therefore the economic rent for the four untis is \$32, for the 3rd unit the economic rent is 32/4 = 8, therefore for the third unit the economic unit is 24, transfer earnings is equal to 32 – 24 = \$8.

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Cost Per Unit of Output

If three units are employed then \$42 is paid and only 30 should be paid, in this case therefore the economic rent is \$12. Economic rent occurs when there is imperfect competition in the market; this can be because of monopolistic form of market.

C14 – How would your neighbor loudly playing a stereo exemplify a negative externality? Explain

Externalities are experienced when the production process fails to record all costs or benefits. Negative externalities occur when the production process will not record all costs in production. In the case of loud music by a neighbor this will lead to negative externalities, externalities will be realized as a result of noise pollution, a neighbor may want to study but due to the loud music may fail to concentrate, the neighbor may play loud music at night and this may make his or her neighbors to have sleepless nights, therefore loud music by a neighbor will be regarded as a negative externality.

C15 – How would you compare wages earned in the private sector with wages earned in the public sector? Why the difference?

There may be market failure and the government may intervene to improve on such a situation, however the government may cause harmful interference in the market but this does not mean that the government should not intervene. In a free market the price for products and factors of production are determined by the supply and demand, the private sector is a free market and therefore will offer wage rates determined by the supply and the demand. In the public sector the wage rate is adopted by a government or from the market, for this reason therefore the public sector wages will be different from private sector wages in that in the private sector the wage rates are determined by demand and supply why the government will only adopt a wage rate to pay its employees.

## REFERENCE:

Philip Hardwick (2004) Introduction to Modern Economics, Pearson Press, New York

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