B.A.

Economics;
Time: 60M
MM=20
Attempt All Questions
Q1. Let’s assume a two-person economy where the utility function of person 1, as a function
of her consumption x1 of a pure private good, and z1 of a pure public good, could be written
as
U 1 (x1, z1) = ln x1 + ln z1 (where “ln x1” means the natural logarithm of x1)
and that the utility function of person 2 could be written (as a function of his consumption x2
of the private good and z2 of the public good)
U 2 (x2, z2) = ln x2 + ln z2
These are both examples of Cobb–Douglas utility functions 1. The two people also have
different preferences: relative to person 1, person 2 has a stronger taste for the public good
and a weaker taste for the private good. Further Suppose that the equation of the economy’s
production possibility frontier is
X = 120 – Z, where X=X1 + X2.

1. Find the optimum level of Public Good (Z)? [3]

2. Find the two Pareto Optimal Allocations? [3]
3. What is Public Good? Are they provided by market? Justify. [4]

Q2. “Nearly 80% of the e-mails sent in the world are unwanted spam. All of this junk e-mail
wastes your time, clogs e-mail inboxes, and can eat up valuable bandwidth and make the
Internet slower.” In the given situation what economic problem do you see? Identify the
underlying economic problem and suggest how you might solve this problem. [2]

Q3. Suppose that the inverse demand for marching band music is given by
P = $1,000 – Q.
Because marching bands across the world produce music of sufficient quality at increasing
marginal cost, the industry marginal cost is given by
MC = 0.75Q.
Unfortunately, marching band music is not produced in a vacuum: People near marching
bands become increasingly aggravated the more music they hear. At the industry level, the
external marginal cost is given by EMC = 0.25Q.
a. Graph the demand, marginal cost, and external marginal cost functions. [2]
b. If marching bands do not consider the external marginal costs they impose on others, how
many songs will be played? [2]
d. Determine the quantity of marching band music that would be produced if marching bands
were forced to consider the costs they imposed on others. [2]
e. What happens to the price of marching band music if the bands were forced to consider the
external marginal costs? [2]