UNIVERSITY OF THE PHILIPPINES

SCHOOL OF ECONOMICS

ECONOMICS 100.2
Introduction to Microeconomic Theory and Policy
Problem Set No. 1

Prof. Aleli Kraft / Ang / Panti / Siton 2nd Semester, AY 2016-2017

MULTIPLE CHOICE

I.
1. The term market failure refers to
a. a market that fails to allocate resources efficiently.
b. an unsuccessful advertising campaign which reduces demand.
c. ruthless competition among firms.
d. a firm that is forced out of business because of losses.

2. An externality exists whenever

a. the economy cannot benefit from government intervention.
b. markets are not able to reach equilibrium.
c. a firm sells its product in a foreign market.
d. Bobbi engages in an activity that influences the well-being of Rosa and yet Bobbi neither
pays nor receives payment for that influence.

3. Which of the following statements about a well-maintained yard best conveys the general nature
of the externality?
a. A well-maintained yard conveys a positive externality because it increases the home's market
value.
b. A well-maintained yard conveys a negative externality because it increases the property tax
liability of the owner.
c. A well-maintained yard conveys a positive externality because it increases the value of
adjacent properties in the neighborhood.
d. A well-maintained yard cannot provide any type of externality.

4. Which of the following statements is not correct?

a. Government policies may improve the market's allocation of resources when negative
externalities are present.
b. Government policies may improve the market's allocation of resources when positive
externalities are present.
c. A positive externality is an example of a market failure.
d. Without government intervention, the market will tend to undersupply products that produce
negative externalities.

5. Altering incentives so that people take account of the external effects of their actions
a. is called internalizing the externality.
b. can be done by imposing a corrective tax.
c. is the role of government in markets with externalities.
d. all of the above.
 II. Answer A if both statements are true, B if both statements are false, C if the first statement is true,
and the second statement is false, D if the first statement is false, and the second statement is true.

C 1. When goods are available free of charge, the market forces that normally allocate resources in our
economy are absent.

Free goods are usually efficiently allocated without government intervention.

Text 2. Government intervention cannot improve the allocation of resources for goods that do not have
prices attached to them.

PTV-4 would be considered a club good.

Text 3. Some goods can be classified as either public goods or private goods depending on the
circumstances.

In some cases the government can make everyone better off by raising taxes to pay for certain
goods that the market fails to provide.

Text 4. The free-rider problem makes it unlikely that poverty will be entirely eliminated through private
charity.

Private markets usually provide lighthouses because ship captains have the incentive to navigate
using the lighthouse and therefore will pay for the service.

Text 5. Aristotle writes, What is common to many is taken least care of, for all men have greater regard
for what is their own than for what they possess in common with others. In this statement,
Aristotle is referring to the free-rider problem that occurs when a person receives the benefit of a
good without paying for it.

An example of the Tragedy of the Commons is litter in the picnic area of a local park.

WORD PROBLEMS

1. Higher quantity of alcohol consumed is associated with more road accidents and, thus, brings
costs on safe and sober drivers.
a. Draw the alcohol market, labeling the demand curve, the social-value curve, the supply
curve, the social-cost curve, the market equilibrium level of output, and the efficient level
of output.
b. Shade the area corresponding to the deadweight loss of the market equilibrium. Explain.
2. The Westworld pollution agency wants to decrease pollution to 150 units, so it gives each firm 50
tradable permits for pollution. Each permit lets you pollute 1 unit, and each producer wants to
retain their initial level of pollution.

Producer Initial Level (Pollution) Pollution Reduction Cost

A 90 units Php 30 per unit
P 110 units Php 35 per unit
S 70 units Php 15 per unit

a. In this scenario, elaborate on why the buyers/sellers have the incentive to trade (if any). By
how many units will be bought/sold from whom to whom? What will be the resulting total
pollution reduction cost?

b. How much costly pollution reduction would be for all producers if no permits were tradable
after the initial allocation?

3. Board mates are organizing a movie marathon in their dorm room to watch the Academy
nominees, and they are contemplating on which of the five (5) movies they would select for the
marathon. For each movie, their corresponding willingness to pay (WTP) is:
Greg Ricardo Rene George
Moonlight Php 140 Php 100 Php 60 Php 40
La La Land 120 80 40 20
Hidden Figures 100 60 20 0
Arrival 80 40 0 0
Fences 60 20 0 0

a. Is the movie marathon within the dorm room a public good? Explain your answer.
b. If the rental rate for each movie is Php 160, how many movies should each watch?
c. Given that Php 160 is the rental rate for movies, the optimal count of movies, and the cost
of the movie marathon split equally, what is the corresponding consumer surplus for each
board mate?
d. Is there another way to collect contributions from all board mates to ensure every person
benefits from the movie marathon? What problems may rise from your proposed solution
given the nature of the movie marathon?
e. Assume that they agree in advance to choose the efficient number and split the cost of the
movies equally. When Greg is asked his WTP, will he have any incentive to tell his true
WTP? If yes, why? If no, what will he be opt to say instead?
f. What does the problem of the movie marathon teach you about optimal public good
provision?