Tuesday, April 7, 2015

2013 AP Microeconomics Exam FRQ #3

2013 AP Microeconomics Exam FRQ #3

(a) Draw a CLG of the market for fireworks and show the market equilibrium price and quantity, labeled, Pe & Qe.
(b) Assume the noise from the fireworks disturbs all of the neighbours. On your graph in part (a), show each of the following.

(i)   The marginal social cost curve, labeled MSC
(ii)  The marginal social benefit curve, labeled, MSB
(iii) The dead weight loss, if any, shaded completely.

(c) Now assume instead, that all of your neighbours enjoy watching the fireworks.
(i)  In this case, is the market equilibrium quantity of fireworks greater than, less than, or equal to the socially optimal quantity?

As we can see, when the externality is drawn with the fireworks being enjoyed,, there still is an externality in that someone is benefitting from the fireworks,, and someone is not being compensated for providing that benefit.

Answer - the fireworks now generate a positive externality and the market equilibrium is less than the socially optimum quantity. There is still an externality and deadweight loss showing a benefit to a third party.

(ii) If the government bans fireworks will the deadweight loss, increase, decrease, or remains the same.

If people enjoy fireworks and the government bans them,, then society is moved farther from the socially optimal quantity. Remember, DWL is inefficiency meaning that some people are not getting served that should,, that is why with a positive externality the government usually wants to subsidise the cost so that more people will have the merit good.

So, this is what the deadweight looks like after a government ban.
Answer - deadweight loss has definitely increased.

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