Chapter 5: discussion questions 3, 4, 5, 7, 9, 13 and 14

3)

During the Democratic presidential primary campaign in 2008, Governor Bill Richardson said he
favored a cap-and-trade approach for carbon regulation rather than a carbon tax because the latter
is “passed on to consumers” and so is a bad idea”. Then senator Barack Obama disagreed, saying
that both the carbon tax and the cap-and-trade program lead to higher costs for consumers. Which
candidate was correct about the distributional impacts of the two policies?

4)

In the following figure, the number of parties that Casanova gives per month is measured on the
horizontal axis, and dollars are measured on the vertical. MCP is the marginal cost of providing both
parties and MBP is Casanova’s marginal benefit schedule from having parties

- Graphically, show how many parties Casanova will host

- Suppose there is a fixed marginal external benefit €b per party to Casanova’s friends.
Illustrate this on your graph
o See the line MSBP
- What is the socially optimal level of parties? How could the Social Committee induce
Casanova to throw this number?
o P* is the social optimal level of parties. The social committee could induce Casanova
to throw this number of parties by providing her a per-unit subsidy of $b per party
- On the graph, who the optimal subsidy per party and the total amount paid to Casanova.
Who gains and loses under this plan?
o The total subsidy equals the rectangle abcd. Society comes out ahead by ghc,
assuming the subsidy can be raised without any efficiency, assuming the subsidy can
be raised without any efficiency costs. (Casanova’s friends gain gchd, Casanova loses
chd but gains abcd, which is a subsidy cost to government)

5)

In turkey, many shopping mall owners charge different rental rates on their tenants. The shops of
local and relatively unknown brands pay higher rental rates per square meter than international and
famous brand shops. Local shop owners protest this differential rental system. What motivates mall
owners to use different rates
International brands bring costumer to the malls, which is also beneficial for the local stores

7)

For each of the following situations, is the Coase Theorem applicable? Why or why not?

Coase theorem is a legal and economic theory that affirms that where there are complete
competitive markets with no transactions costs, an efficient set of inputs and outputs to and from
production-optimal distribution are selected, regardless of how property rights are divided. The
theorem states that where there is a conflict of property rights, the involved parties can bargain or
negotiate terms that are more beneficial to both parties than the outcome of any assigned property
rights. It also assets that in order for this to occur, bargaining must be costless; if there are cost
associated with bargaining, such as those relating to meetings or enforcement, it affects the
outcome

- A farmer grows organic corn is at risk of having his crop contaminated by genetically
modified corn grown by his neighbours
o It is very likely that the farmer could negotiate with the neighbours, provided
property rights are clearly defined. Coase Theorem is applicable

- In Silveiras, Brazil, queen ants are regarded as delicacy, but recently the ant haul has been
dwindling because of pesticides used on eucalyptus trees that are planted to produce
cellulose for paper and other products
o it is unlikely that property rights could be enforced in terms of catching queen ants in
Silveiras. Would it be appropriate to give compensation to people making a living of
selling queen ants, or to people consuming the ants, or should one compensate the
production of cellulose for paper and other products in order to make them stop
using pesticides? Given the large number of people who are involved in both sides,
costs of negotiations are very likely to be costly and hence coase theorem does not
apply

- Following a military coup in Madagascar, a weak president was installed who was unable to
stop the selling of Rosewood trees to China that were illegally cut down from the national
parks
o Depends on the number of sellers, if only a small group private negotiations may be
possible

- Users of the internet generally incur a zero incremental cost for transmitting information.
Consequently, congestion occurs, and users are frustrated by delays
o Too many people are involved for private negotiation and impossible to figure out
how to transfer bribes

9)

In India, a drug used to treat sick cows is leading to the death of many vultures that feed off f of
dead cattle. Before the decrease in the number of vultures, they sometimes used to smash into the
engines of jets taking off from New Delhi’s airports, posing a serious threat to air travellers,
However, the decline of the vulture populations has led to a sharp increase in the populations of rats
and feral dogs, which are now the main scavengers of rotting meat. There have been calls for a ban
on the drug used to tread the cows.
Identify the externalities that are present in this situation. Comment on the efficiency of banning the
drug. How would you design an incentive-based regulation to attain an efficient outcome?

The use of the drug to treat sick cows leads to a positive externality (the benefit enjoyed by air
travellers) as well as a negative externality (the costs created by a larger number of rats and feral
dogs). Banning the drug might raise or lower efficiency, depending on whether the positive
externality is larger or whether the negative externality is larger. There are many ways to design
incentive-based regulations. Policymakers could determine the efficient level of drug usage and then
either allocate or sell the right to use the drug for sick cows

13)

The Kyoto Protocol has tried to create an international framework where greenhouse gas emissions
are limited through a cap-and-trade system. So far, it has experienced very limited success. The
actual greenhouse emissions of many countries are considered to be much higher than efficient
levels. Explore the challenges experienced during the drafting and implementation of the protocol.
What would the Coase Theorem predict about the emission levels? Why weren’t these predictions
realized?

Coase theorem predicts provided that transaction costs are negligible, an efficient solution to an
externality problem is achieved as long as someone is assigned property rights, independent of who
is assigned those rights

May not be possible in the case of the Kyoto Protocol due to: The costs to the parties of bargaining is
not likely to be low and the owners of resources cannot easily identify the source of damages to their
property and legally prevent damages

Suppose that the marginal cost of emissions is very uncertain. In this case, would you suggest
emission fees or cap-and-trade?

Inelastic schedule: the first units of pollution reduction are highly valuable, but as more reductions
occur, their incremental benefit falls off rapidly. Cap-and-trade system is preferable to an emissions
fee when marginal social benefits are inelastic and costs are uncertain. Intuitively, when marginal
social benefits are inelastic, a change in cost has very little effect on the optimal amount of pollution
reduction. Therefore, a cap-and-trade system (which fixes the amount of allowable pollution) won’t
deviate much from the new efficient level

When marginal social benefits are inelastic and costs are higher than expected, neither cap-
and=trade nor an emissions fee is perfectly efficient. Cap-and-trade achieves too much pollution
reduction and an emissions fee achieves too little pollution reduction. However, cap and trade is
more efficient

Elastic schedule: the marginal value of each unit of pollution reduction remains fairly constant.

Intuitively, when marginal social benefits are elastic, a change in cost has a big effect on the optimal
amount of pollution reduction. Therefore, a cap-and-trade system (which fixes the amount of
allowable pollution) deviates substantially from the new efficient level

When marginal social benefits are elastic and costs are higher than expected, neither cap-and-trade
nor an emissions fee is perfectly efficient. Cap-and trade achieves too much pollution reduction and
an emissions fee achieves too little pollution reduction. However, an emission fee is more efficient

14)
Figure 5.11. demonstrates the efficiency implications of using cap-and-trade versus an emission fee
when costs are higher than expected and marginal social benefits are inelastic. Figure 5.12 does the
same thing under the assumption of elastic marginal social benefits. Now consider the case where
marginal costs turn out to be lower than anticipated. For both cap-and-trade and an emission fee,
show whether there is too much or too little emissions reduction. Which approach is more efficient
when marginal social benefits are inelastic and when they are elastic?

If marginal costs turn out to be lower than anticipated, cap-and-trade achieves too little pollution
reduction and an emissions fee achieves too much pollution reduction. With an inelastic marginal
social benefit function, cap-and-trade is not too bad from an efficiency standpoint, while an
emissions fee causes pollution reduction to be much greater than the efficient level when marginal
cost is lower than anticipated. When marginal social benefits are elastic, the opposite is ture

Additional Question

Quantum computing is a revolutionary method of performing calculations far beyond the

capabilities of common binary computing. Although development of this technology is in its infancy,
the prospects of its application in industries such as business, defense and security is promising. The
research that has led to this innovation as well as current development is primarily but not
exclusively financed by government agencies.

Would a typical neoclassical economist support the government funding of quantum computing?
Why (not)?