2017 AP Microeconomics FRQ #3

2017 AP Microeconomics FRQ #3

(A) Identify the monopolists.

(i) Profit maximising quantity

(ii) Profit maximising price

Recognise, that the MPC is the MC curve and that the MR = MPB, therefore the Profit Max for this Monopoly is where MR = MC, 

Price = P4 

Quantity = Q3

Answer

(B) What information in the graph indicates that there is a negative externality?

MSC > MPC = Negative Externality

Answer

(C) Identify the socially optimal quantity.
Social Optimal Quantity is where MSB = MSC
Social Optimal Quantity = Q3

Understand: This time the monopoly is producing an output that is equal to the socially efficient amount, Here the welfare losses caused by the negative externality are less in a monopoly environment than they would be in a competitive environment. This is a point worth remembering when it comes to things like energy markets. People naturally assume that competitive markets are better than ones with market power, but if there is a negative externality of pollution that comes with consuming energy, then the economic welfare effects may be less bad for society if there is a monopoly or oligopoly provider producing a lower amount at higher price for consumers (and enjoying high profits) than if there was a competitive market, prices were forced down for consumers, and an excessive amount of energy was consumed.

Answer

(D) In the case in which the government imposes a per-unit tax equal to the marginal external cost, identify each of the following.

(i) The dollar value of the tax, using the price labels from the graph

The tax would be equal to the vertical distance between the MSC and MPC. (P4 - P1) 

(ii) The profit-maximising quantity associated with the tax.

Answer

(E) Given the monopoly facing the negative externality, would the dead-weight loss increase, decrease, or stay the same as a result of imposing the per-unit tax? Explain.

Answer

ARTIST

Market Failure 2 - Negative Production Externality

Negative Production Externality

Negative Production Externality: The type/name of the externality tells you what you need to do!

Negative = Negative (duh!) (we want less of it)
Production = Production = Costs = Supply (there will be two supply curves, MSC & MPC)

• Negative = we want less
• Production = costs = supply
• Triangle = DWL (dead weight loss) (points to society) & is between the two supply curves
• SOQ = Socially Optimal Quantity or the quantity desired by society (Neg.=less quantity)
• Overproduction =  If we want less we must be over producing the good (duh!)
• MSB = MSC, obviously where social benefits and costs equal,  equilibrium quantity- Q*
• CLG - always a correctly labelled graph

• Triangle - always points to society - to help you know which supply/cost curve is drawn above or below, know that the triangle always points to (MSC) society for a Negative Production Externality... Your going to say,, but Charles I could draw the curve pointing to the right and still have it between the curves,,, but then the triangles point will be pointing to an equilibrium of more production (we need less).
• Check your graph and make sure it is showing what you want,,, to get less production prices must go higher. (look above and you will see this is exactly what has happened, prices have increased and quantity produced has fallen.)

In the graph above the most used reason for a negative production externality to happen is due to pollution, (water, air, soil, road congestion). Pollution therefore harms society at some level, society being the injured third party. To correct for the cost of the pollution imposed on society an indirect tax equal to the size of the external cost (pollution harm to society) is imposed on the firm to make them pay for their pollution (to get them to internalize the cost they have placed upon society) The tax causes their production processes to become more expensive and they produce less (hopefully). Known as the "Polluter pays principle" designed and formulated by Pigou (1920) also known as a Pigovian tax,,  a carbon tax is a Pigovian tax.

The government must estimate the harm done to society and propose an amount of tax that causes the firm to produce at the new lower level, Q*. That is difficult. Also, as you know now the PED of a good also effects the amount consumers or producers will assume of the tax. 

Draw this graph about 50 times and explain to yourself what is happening.

Examples:

• 1995 AP Microeconomics Exam:

Answer (B) encourage firms to use the most efficient method to reduce pollution.

• 1995 AP Microeconomic Exam:

Answer (C) The private market price will be to low. 

(notice in the graph at the top of the page the Price is low and then the SOQ (socially optimal quantity) is Q* produced with the higher Price.

• 2000 AP Microeconomics Exam:

Answer (C) society's marginal cost being higher than the firms marginal cost.                               (check out the graph above)


• 2000 AP Microeconomics Exam:



• 2005 AP Microeconomics Exam:

Answer (A) The price of cigarettes will be two low and the quantity sold will be to high.                                   (overproduction)

• 2005 AP Microeconomics Exam:

Answer (B) The production or consumption of a good generates a negative externality.

• 2008 AP Microeconomics Exam:

Answer (B) Price will be less than the marginal social cost.

Welker on Negative Externalities of Production: Video