Chapter 04 - Market Failures: Public Goods and Externalities

McConnell Brue Flynn 19e

DISCUSSION QUESTIONS

2. Use the ideas of consumer surplus and producer surplus to explain why economists say competitive
markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these
two sets of ideas? LO2

Answer: When the consumers’ utility exceeds the price paid, consumer surplus is generated. Likewise,
when producers receive a price greater than marginal cost, producer surplus is created. By producing up
to the point where MB = MC, the maximum potential consumer surplus and producer surplus is generated.
Producing less than the equilibrium level means that potential surplus is left unrealized. Overproduction
subtracts from the surplus because society values the use of the additional resources in other pursuits more
than it values them in consumption of that good.

REVIEW QUESTIONS

4. Draw a production possibilities curve with public goods on the vertical axis and private goods on the
horizontal axis. Assuming the economy is initially operating on the curve, indicate how the production of
public goods might be increased. How might the output of public goods be increased if the economy is
initially operating at a point inside the curve? LO3
Answer: On the curve, the only way to obtain more public goods is to reduce the production of
private goods (from C to B). An economy operating inside the curve can expand the production of
public goods without sacrificing private goods (say, from A to B) by making use of unemployed
resources.

PROBLEMS

5. On the basis of the three individual demand schedules below, and assuming these three people are the
only ones in the society, determine (a) the market demand schedule on the assumption that the good is a
private good and (b) the collective demand schedule on the assumption that the good is a public good.
LO3

Answers: (a) Market demand schedule

Quantity Demanded Price

1 $8
2 $7
4 $6
7 $5
10 $4
13 $3
16 $2
19 $1

(b) Collective demand schedule

Quantity Amount Society is

Willing to Pay
1 $19
2 $16
3 $13
4 $10
5 $7
6 $4
7 $2
8 $1
Feedback: Consider the following table:

Part (a): Derive the market demand schedule on the assumption that the good is a private good. To
accomplish we use the principle of horizontal summation. That is, we fix price and add up the
quantities demanded by the individuals.

At a price of $8: individual 1 (I1) demands 0, individual 2 (I2) demands 1, and individual 3 (I3)
demands 0. Thus, we have the following market demand ordered pair (1,8).

At a price of $7: I1 demands 0, I2 demands 2, and I3 demands 0. Thus, we have the following
market demand ordered pair (2,7).

At a price of $6: I1 demands 0, I2 demands 3, and I3 demands 1. Thus, we have the following
market demand ordered pair (4 [=3+1],6).

At a price of $5: I1 demands 1, I2 demands 4, and I3 demands 2. Thus, we have the following
market demand ordered pair (7[=1+4+2],5).
At a price of $4: I1 demands 2, I2 demands 5, and I3 demands 3. Thus, we have the following
market demand ordered pair (10,4).

At a price of $3: I1 demands 3, I2 demands 6, and I3 demands 4. Thus, we have the following
market demand ordered pair (13,3).

At a price of $2: I1 demands 4, I2 demands 7, and I3 demands 5. Thus, we have the following
market demand ordered pair (16,2).

At a price of $1: I1 demands 5, I2 demands 8, and I3 demands 6. Thus, we have the following
market demand ordered pair (19,1).

Part (b): Derive the collective demand schedule on the assumption that the good is a public good.
To accomplish we use the principle of vertical summation. That is, we fix quantity and add up the
price (willingness to pay) for the individuals. The logic here is that the individuals (society) can
pool resources to purchase a given quantity because this good will be shared (public good).

At the quantity 1: I1 is willing to pay $5, I2 is willing to pay $8, and I3 is willing to pay $6. Thus,
we have the following collective demand ordered pair (1,19=5+8+6).

At the quantity 2: I1 is willing to pay $4, I2 is willing to pay $7, and I3 is willing to pay $5. Thus,
we have the following collective demand ordered pair (2,16).

At the quantity 3: I1 is willing to pay $3, I2 is willing to pay $6, and I3 is willing to pay $4. Thus,
we have the following collective demand ordered pair (3,13).

At the quantity 4: I1 is willing to pay $2, I2 is willing to pay $5, and I3 is willing to pay $3. Thus,
we have the following collective demand ordered pair (4,10).

At the quantity 5: I1 is willing to pay $1, I2 is willing to pay $4, and I3 is willing to pay $2. Thus,
we have the following collective demand ordered pair (5,7).

At the quantity 6: I1 is willing to pay $0, I2 is willing to pay $3, and I3 is willing to pay $1. Thus,
we have the following collective demand ordered pair (6,4).

At the quantity 7: I1 is willing to pay $0, I2 is willing to pay $2, and I3 is willing to pay $0. Thus,
we have the following collective demand ordered pair (7,2).

At the quantity 8: I1 is willing to pay $0, I2 is willing to pay $1, and I3 is willing to pay $0. Thus,
we have the following collective demand ordered pair (8,1).