HOMEWORK 6 1. Draw the (unregulated) market supply and demand for the lawn ornament market. The data on how many of each type of buyer and seller will be provided with the experimental data. Bear in mind that pollution imposed a *0.5 cost on every person in the market, including the buyer and seller. There is a subtle point in this question. If a buyer with value 25 buys at a price of 20, the net profit (consumer surplus) from this transaction is 4.5, because the number of lawn ornaments increases and there is added pollution. Thus, a buyer with value 25 is willing to pay at most 24.5 for the ornament. Similarly, a seller who sells increases pollution; thus a seller with cost 23 should not sell at any price less than 23.5. 2. What is the predicted price and quantity? What was the actual quantity and average price? 3. What is total number of people present in your group? The total pollution cost per unit sold is one-half of this number. Viewing that as a cost (to society), draw the "total social marginal cost" (which is the sum of the marginal private cost (not counting any pollution effects) to individual sellers and the external cost of pollution) on your figure. What is the socially efficient number of transactions? Take care not to double-count the pollution cost (e.g. you already accounted for the cost to a seller of his own pollution). 4. In experiment 6.2, a *20 tax was imposed on sellers. How does this affect supply? In a second figure, draw the new supply and demand curves, after the tax. 5. What is the predicted price and quantity? What was the actual quantity and average price in Experiments 6.2? 6. experiment 6.4 involves two markets, the market for lawn ornaments and the market for pollution permits. How many pollution permits were available in your group? Produce the supply and demand figure for the experiment 6.4 data (do not draw social marginal cost) and add the pollution permit quantity restriction as a vertical line. What is the difference in the buyer's value and seller's cost at that quantity? 7. Why is that difference - the difference between marginal value and marginal cost at the quantity of pollution permits - the value of pollution permits? 8. Pollution permits were given out free to particular buyers and sellers. In a new figure, draw the supply curve for the pollution permit market. What does the demand curve look like? (Hint: you figured out the willingness to pay for pollution permits only for the actual quantity of pollution permits. For other quantities, the logic is the same but the numbers will be different.) 9. What is the predicted quantity of lawn ornament transactions? What is the predicted price (charged to buyers) for lawn ornaments? How does this compare to the actual quantity and average price? 10. Does it matter who gets the permits, if the number is held the same? 11. Until the 1980s, the U.S. has given out permits to polluters based on historical pollution levels (for example, a polluter might be permitted to produce 75% of their 1975 level of pollution). Why does it matter if permits can be bought and sold? 12. California has started auctioning the right to pollute in the Los Angeles area, and permits are tradeable. What effects does auctioning pollution rights have, in comparison to assigning the rights to historical polluters? 13. The Sierra Club buys pollution permits and then doesn't use them, as a way of reducing total pollution. Polluters say the Sierra club should not be permitted to do this, because it raises the price of the permits. What is wrong with the polluter's argument? (Hint: who is the highest value user of permits?) Food for thought (not to be handed in): Households face many of the same problems faced by the nation as a whole. Playing loud music late at night imposes a negative externality on others. Dropping food in the couch attracts insects that affect everyone. Stacks of dirty dishes in the sink are unsightly for everyone. How does your household respond to these issues? If you live alone, of course, there are no externalities on others (unless your neighbors can hear your music, or the bugs get into their apartment). Households also respond to these problems in a manner similar to society - by regulation. Households may have "no loud music after 9 PM" rules, or "dishes must be washed within an hour of being put in the sink." These rules are quantity restrictions, or prohibitions. How does your household respond to exceptions? Are deals permitted, where someone gets permission to have a party on a weeknight to celebrate a special occasion? What sort of quid pro quo is expected - if you have a party, I can have one too? Or, if you have a party, you'll wash my dishes for a week? Implicitly, such deals put a price on the externality, and work like a tax. Consider two households composed of identical (e.g. cloned) individuals. In the first household, loud music is prohibited, although deals can be made. In the second household, loud music is permitted, although again deals can be made. Do we expect a difference in the frequency of loud music in these two households? The surprising answer is no. In the first household, an individual wanting loud music can pay the others to permit it. This will work whenever that individual values the music more than the cost to others. In the second household, the others can pay the offending party to be quiet. Again, this should work whenever the others value quiet more than the individual values the music. In either case, we would expect that the music is played only when it is worth more to the individual than its cost to society. The difference in these two households is known as a difference in property rights. In one case, one has the right to silence. In the other, one has the right to music. In terms of the outcome, it may not matter who has the property rights, provided one can sell the right. Then, the most socially valuable outcome occurs. This insight, known as the Coase Theorem (Ronald Coase won a Nobel Prize for this and other insights) doesn't usually work perfectly. Individuals may try to conceal how much they value having music, in order to pay less in the future. It may be difficult to get a group organized to buy silence. But like our tradeable pollution permits, the ability to trade property rights generally improves the social outcome - because one sells a right only when one receives adequate compensation, so everyone is better off.