1 Negative Externality

Suppose that the private market for widgets is characterized by the following supply and inverse

demand functions:

D : P = 10Q

S : P = Q

1. Graph these functions in the graph paper below. Locate the private market equilibrium price

and quantity.

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pace university|economics 310|yarbrough spring 2019 – assignment 1

2. Now suppose that the EPA calculates that the marginal external cost of widget production is

characterized by: MD = $2. Graph the market with the externality and locate the the socially

ecient equilibrium. How much dead weight loss was produced by the private market.

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pace university|economics 310|yarbrough spring 2019 – assignment 1

3. Now suppose that the EPA revises their MEC estimate to: MD = Q. Graph the market with

the externality and locate the socially ecient equilibrium. Compare this with the outcome

from part 2.

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pace university|economics 310|yarbrough spring 2019 – assignment 1

2 Public Goods

Suppose that the private market demand for acres in the town of Yarbroughville

(Q) is characterized by the following two types of voters (old and young):

Dold : Q = 10P

Dyoung : Q = 8P

Further, assume that the marginal cost of supplying acres of public-access park is:

MC : Q = 0.25P

1. If park acres would be determined by a private market, how many acres are bought and sold?

To determine this, plot the two demand curves separately, and then sum them horizontally to

plot a market demand curve. Then nd the private market equilibrium.

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pace university|economics 310|yarbrough spring 2019 – assignment 1

2. Instead, assume that park acres are determined by a on willingness to pay.

How many acres of public-access park are socially ecient? To determine this, again graph the

two demand curves separately and then sum them vertically to plot a .

Now locate the socially ecient equilibrium.

3. Briey explain why it is that the private market supplies less public-access park acres than

would be supplied if they were oered publicly.

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pace university|economics 310|yarbrough spring 2019 – assignment 1

3 Cost-Benet Analysis

Pace University is deciding between two projects.

A) Full HVAC system overhaul, which costs $1 million and will reduce general energy cost to the

university of $300,000 per year. There are no costs beyond period 0.

B) Placing a wind farm on top of 1 Place Plaza, which costs $10 million and will reduce general

energy cost to the university of $3 million per year. There are $500 thousand per year of upkeep

cost for the windmills.

1. Assuming a discount rate of 5% and time periods as years, what is the NPV of each project

after 5 years.

2. Answer part 1 again, but assume a discount rate of 10% instead.

3. Comment on the values calculated in parts 1 and 2.

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