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Answers to Back-of-the-Chapter Problems
1. Although there could be some cost economies from such a merger, the
main effect on consumers likely would be higher soft-drink prices.
2. a. With total output Q = 200,000 units, the resulting equilibrium price is:
P = $80. Therefore, total industry profit is: π = (80 - 60)(200,000) =
b. With LAC = LMC = $50, the merged firm maximizes profit by setting
c. If there a merger were to take place, the new firm’s profit would be: π
= (85 - 50)(175,000) = $6,125,000. In turn, consumer surplus would be:
½(120 – 85)(175,000) = $3,062,500. Though the slight increase in price
3. a. Setting MR = MC, we have: 500 - 20Q = 150, or QM = 17.5 thousand
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c. With a $100 tax, the monopolist’s MC is 250. Setting MR = MC, we
d. The efficient solution calls for a double dose of regulation: promote
perfect competition while taxing the externality. The efficient price is:
PC = LMC + MEC = 150 + 100 = $250. The corresponding (efficient)
4. a. If management and workers have perfect information about job risks in
mining, there is no externality. The two sides should be able to
b. The competitors of these large brokerage firms receive a positive
externality: more productive new hires whose training was paid for by
c. Spam is an obvious externality. Spammers send out millions of mass
d. The couple incurs an adverse effect, but this is not an externality. Rising
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5. a. The competitive price of studded tires is PC = AC = $60. The price
b. The full MC of an extra tire is 60 + .5Q. Equating industry demand to
marginal cost, we find P = 170 - 5Q = 60 + .5Q. Therefore, the optimal
quantity is Q* = 20 thousand tires. The optimal price is 170 - (5)(20) =
c. At Q* = 20 thousand tires, the marginal external cost is .5Q* = $10 per
d. At an added cost of $12, low-impact studded tires are not cost effective.
6.a. Do families make well-informed, rational decisions concerning
b. One point of view is that workers and employers already structure
efficient labor contracts – ones providing the optimal amount of
workplace safety (at the least total cost). According to this argument,
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c. By law, there must be access for the disabled. However, the cost of
modifying existing buildings and transport is often very high. In some
d. The Department of Agriculture should tradeoff the benefits of pesticides
e. Maintaining the infrastructure should be a matter of benefits and costs,
7. a. The firms’ costs are C1 = 2Q1 + .1Q12 and C2 = .15Q22. It follows that
b. Setting MB = MC1 = MC2, we find Q1 = 5 and Q2 = 10, and the common
c. Each firm cleans up to the point where MC = $4; Using the MC
d. The optimal tax is $3.00 (equal to the common value of MB = MC1 =
8. a. Yes, this is a prisoner’s dilemma. It does not pay for any block to
b. A multilateral .2 reduction by each block does not quite work; for the
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c. The efficient scheme – found by comparing the marginal benefit and
marginal cost of emission reduction – has EUS = 1.2, EEU = .8, and
The net benefits (relative to the status quo are: U.S. (24 - 0),
Europe (32 - 18), and DNs (38 - 48). Clearly, the developing nations
9. a. To maximize net benefit (i.e. benefit minus cost), RWE should compare
MB and MC, where MC = $150,000 per facility. The optimal number of
b. The additional benefit to society means that MB increases by $75,000.
Now the optimal number of facilities is N = 6. Adopting the program at
c. Requiring N = 8 reduces total net benefit relative to N = 6 in part b. The
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d. Without any regulatory intervention, RWE would enroll only 4 facilities
in the health and safety program (as in part a). An OSHA subsidy per
10. a. This rule makes sense when deciding whether or not undertake a single
b. The benefit-cost ratio does not reveal any information about the scale
of either project. Therefore, it cannot be used to decide between the
two. For instance, suppose the library’s total benefit is $1,500,000 and
its total cost is $1,000,000. The garage’s total benefit is $1,400,000 and
c. This strategy makes great sense. The state should repair bridges where
the benefit is greatest per dollar spent, i.e., where the “bang is biggest
11. a. Sketching the demand curve, we find the price intercept to be $3.00 and
the quantity intercept to be 900 cars. At a rate of $1.50, 450 cars will
park each hour, implying revenue of $675 per hour. In turn, consumer
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b. The private developer would use the $1.50/hour rate because it offers
the greater revenue. The annual profit is (2,600)($675) - 620,000 =
12. a. The developer’s maximum profit is at site A, where the profit is: 12 - 6
= $6 million. However, the final negotiated agreement will be reached
b.If only sites A, B, and D are feasible, no negotiated agreement is
possible because, in each case, the town’s cost exceeds the developer’s
13. a. The total benefits (B) for the programs (per $1 million spent) are
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b. With $7.2 million as the value per life, the program benefits are now
Again, program 1 should be funded up to its limit ($14 million), then
Discussion Question
Imperfect information might be the main reason for lax security at airports.
Until 2002, airlines contracted with private companies to provide security.
Before September 11, air travelers were much more concerned with
convenience and speeding through airports than with security risks. By
underestimating real risks, air travelers downplay the value of security.
Accordingly, they are unwilling to pay the costs (in dollars, inconvenience,
After September 11, the main issue was whether screening should be
done by private employees under strict rules and regulations or by federal
employees Congress opted for the latter alternative. Government provision
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Spreadsheet Problem
S1. a. and b. We can use the spreadsheet optimizer to confirm the results of
each of the analyst’s recommendations. To confirm the monopoly
outcome (the result of analyst A’s policy of laissez faire), maximize
c. To find the optimal output, tax, and quantity of pollution cleaned up,
we maximize total benefits in cell G15 by changing output in cell
B10, the tax in cell C10, and the level of cleanup in cell D10, subject
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