Question 1:

A)

If it is possible to stop anyone from consuming a good, the good is excludable. If it is not
possible to stop anyone from consuming a good, the good is non-excludable. If the
consumption of a good by one consumer affects the consumption of the same good by
other, the good is called rival. If the consumption of a good by one consumer does not
affect the consumption of the same good by other, the good is called non-rival. (Goolsbee,
Levitt, Syverson; 2015)

The good which is excludable and rival is called private good. The good which is non-
excludable but rival is called common pool resource. The good which is excludable and
non-rival is called toll goods. The good which is non-excludable and non-rival is called the
public good.

According to the definitions of “types of good”, college education is defined as toll good
from the surface. This is because, it is possible to exclude someone from taking a college
course if the person does not pay the fee. In some cases, entrance exams create “fee” to
enroll for certain courses and hence exclude people from taking college courses. The
college education is non-rivalrous because each person’s education does not decrease with
other persons consumption. That is every one having the same course will receive the same
education. Hence, college degree is “toll good”.

B)

1. The good which is non-excludable and non-rival is called the public good. The
public goods can be defined as the goods that can be consumed by anyone without
reducing the amount of consumption of others and without keeping anyone from
consuming them. In case of public good the market fails to generate efficient
outcome. The public good is the good that creates benefit for large number of
people including those who does not pay for them. College education generates
positive externality for everyone in the society in terms of increased productivity
and innovative efficiency of the consumer. It also makes a person better citizen that
help improving lives of other citizens as well. (Shaw, 2010) The cost of education
is thus not internalized in the decision of the consumer. Thus, it is argued that the
college education is under suppled. The market fails to generate efficient allocation.
In this sense, the college education can be termed as public good.

2. The good which is excludable and non-rival is called toll goods. According to the
definitions of “types of good”, college education is defined as toll good from the
surface. This is because, for toll good person does not paying for the good can be
excluded. In case of college education, it is possible to exclude someone from
taking a college course if the person does not pay the fee. In some cases, entrance
exams act as “fee” to enroll for certain courses and hence ensuring the excludability
of people from taking college courses. The college education is non-rivalrous
because each person’s education does not decrease with other persons
consumption. That is every one having paid for the same course will receive the
same education. In this way college degree can be termed as “toll good”.

3. The good which is non-excludable but rival is called common pool resource. A
common resource is exhaustive and non-excludable. This means that if everyone
uses it unlimitedly the resource or the benefit of the resource will have worn out in
future, but it is not possible or costly to stop someone from using the resource.
College education is common pool resource in the sense that it is not possible to
stop some from using the benefit of education. It is also not possible to exclude the
person who pays a proper fee to enroll for a course. However, each course has its
seat limitation. The enrollment beyond a limit decreases the quality of the college
education enrollment. This in turn can give rise to the problem commonly called
tragedy of commons. (Musgrave, Musgrave, 1989) Thus in this sense the college
education can be categorized as common pool resource.

4. The good which is excludable and rival is called private good. The private good is
one for which benefit is internalized and consumption is rival. The goods are
subject to exclusion upon paying the price. (Musgrave, Musgrave, 1989) The
college education is private good in the sense that, each individual going for college
education needs to pay the fees for enrolling oneself to the course. Higher education
always acts as a signal for higher productivity in the job market. The person with
the degree gets high paying job in job market. The benefit and the salary from
higher paying job that will be bought from the higher degree is only limited to the
person. The person who pays the price for the education only receives it or
consumes it. Thus, it is possible to exclude people to ripping the benefit of
education from themselves. In this sense the college education can be viewed as
private good. (Shaw, 2010)

C)

1. Allocative efficiency: Allocative efficiency refers to a “criterion deals with the

proper allocation of resources among alternative uses” (Callan, Thomas; 2013).
This also implies Pareto efficient allocation of resources: it cannot be possible to
increase the production of one good without decreasing the production of others.
The allocative efficiency is examined in both market level and firm level.
Allocative efficiency has two elements: assessment of benefit and cost and
analyzing decision of the firm and market at the margin. The benefit to the society
at the margin is given by the demand curve of the good. As consumption of good
rises, marginal benefit of the good falls. The marginal cost of the society is reflected
through the supply curve of the good. The supply curve is the horizontal summation
of all the marginal cost curve of the existing firm. Then the supply curve denotes
the cost of producing one additional unit of good. Allocative efficiency occurs when
 the marginal benefit of the consumer from the good equals the marginal cost of the
good. This is allocative efficiency at the market level. The allocative efficient at the
firm level achieved when the firm makes the decision at the margin. Each firm
maximizes its profit by equating marginal revenue to its marginal cost. In perfect
competition the marginal revenue equals to the price. Therefore, each competitive
firm maximizes its profit by producing the level of output for which its marginal
cost equals to the market price. Now price is equal to the marginal benefit of the
society and when that is equal to marginal cost, the firm achieves allocative
efficiency.

2. Social efficiency: Social efficiency implies efficient allocation of resources when

there is market failure involved due to externality. Social efficiency requires the
internalization of social benefit or cost in efficient equilibrium. (Musgrave,
Musgrave, 1989) The externality arises when a third party gets affected by an
economic transaction. If the economic transaction benefits the third party it will
create a positive externality and if it imposes cost to the third party it will create
negative externality. In case of negative externality, the good is tend to be
overproduced than social optimum. In case of positive externality, the good is tend
to be under produced than social optimum. Economic activity causes pollution.
Pollution is a spillover cost of production that causes inequality and distorts the
allocation of resources. Education has positive externality and thus under produce.
In case of negative externality to achieve social efficiency the social cost of
pollution must be accounted for and should be internalized. This will decrease the
production and the problem of over production of the good will be eliminated. On
the other hand, I case of education the government should subsidize the consumer.
This will increase the demand for education and increase the production of the
good. Hence, the problem of under production will be eliminated. This way in both
cases the social efficiency will be achieved.

3. Imperfect knowledge as a market failure: The market failure occurs when the
market is fails to achieve the efficient allocation of goods and services along all
lines of production and consumption. There can be various reason for market failure
including imperfect knowledge. The lack of information about a product in the
market affects the allocation of resources. If faulty information about an ineffective
drug increases its sales, more resources will be devoted to its production. This will
represent loss and will increase economic inefficiency. The lack of information
gives rise to information asymmetry. In this case either both party does not have
full information or one party has perfect knowledge and the other don’t. The
asymmetric information creates inefficient market outcomes by creating many
problems. Moran hazard is one example of such problems. The moral hazard arises
when one party fails to observe the behavior of another party in an economic
agreement. The Adverse selection problem arises when the asymmetric information
about the quality of the goods being sold increases the quantity of low quality goods
and drives the high-quality goods out from the market.

4. Differentiated goods as a market failure: The perfectly competitive market

implies the most efficient allocation of goods and services. Anything that distorts
the allocative efficiency will give rise to the market failure. In perfect competition
the goods are homogeneous and non-differentiable. If the goods are differentiated
in terms of labeling and other aspects, the market fails to achieve its desired
competitive edge. Product differentiation gives the firm some market power.
Market power enables the firm to charge a price that is not equal to an over marginal
cost of producing the good. This implies the allocative efficiency where the firm
produce the output given by equality of price and marginal cost fails to achieve.
Hence, give rise to market failure. The product differentiation is common practice
in day to day world. The most classic example is branded goods. The branded goods
such as shirts, apparel, shoes, liquor, etc. cost more than its non-branded
competitors. However, these goods are homogeneous in core and produced with
same technology as others. Then the cost of producing a non-branded and branded
good is same. But the price is much higher for branded products. Hence, here the
firm does to take the decision where P=MC. Rather price is determined by the
demand for the level of production the firm choose to produce while taking decision
at the margin (MR=MC). As the firm fails to generate allocative efficiency the
product differentiation give rise to market failure.
Question 2:

a.

The marginal social benefit of the firm is given as

MSB  80  0.2Q

The marginal private cost is given as

MPC  20  0.4Q

At private competitive equilibrium

MSB  MPC
or ,80  0.2Q  20  0.4Q
or , 0.6Q  60
or , Qc  100
 Pc  80  0.2(100)
or , Pc  60

Therefore, the competitive equilibrium is Qc=100 thousands of barrel and Pc=$60.

b.

The marginal social benefit of the firm is given as

MSB  80  0.2Q

The marginal private cost is given as

MPC  20  0.4Q

The marginal external cost is

MEC  0.2Q

Hence the marginal social cost is

MSC  MPC  MEC

That is

MSC  20  0.6Q

At the social efficient equilibrium

MSB  MSC
or ,80  0.2Q  20  0.6Q
or , 0.8Q  60
or , Qe  75
 Pe  80  0.2(75)
or , Pe  65

Therefore, the competitive equilibrium is Qe=75 thousands of barrels and Pe=$65.

c.

The market for factory good is given in the figure below

Figure 1
 d.

I) The competitive equilibrium:

1. Firm: At the competitive equilibrium the firm equate marginal revenue or
marginal private benefit to marginal cost and produce an output for which
marginal profit is zero. The competitive equilibrium is calculated by
simultaneously solving MSB and MPC curve. This yields competitive
equilibrium of 100 thousand barrels of good and competitive price of $60.
2. Society: At the competitive equilibrium the firm does not internalize the
cost of pollution in the river to the society. So, at the competitive
equilibrium the society loses as they have to bear the price of waste. This
also poses the opportunity cost of production. As in allocative efficiency the
marginal benefit must be equal to all marginal costs, in this case the
competitive equilibrium fails to generate allocative efficiency. The market
outcome for output is too high.

II) The social equilibrium:

1. Firm: At the efficient equilibrium the marginal social cost is marginal
private benefit. This implies marginal profit is equal to marginal external
cost of production. At the socially efficient equilibrium the equilibrium
output falls from 100 thousand barrels to 75 thousand of barrel. This means
the firm loses some of its competitive at the efficient allocation. This loss is
given by the area “wxy” in the figure above. Thus, as the firm internalize
the external cost it experiences loss in profit in terms of decreased sales.
2. Society: From the society’s point of view the external cost of pollution is
now internalized in the production cost. The production decision reaches
allocative efficiency as the marginal social benefit is equal to marginal
social cost of production. The fall in opportunity cost of production implies
gain to the society in terms of accumulated reduction in marginal external
cost. Because lower production implies lower wastage and lower cost to the
society. This accumulated benefit is given by the area “wxyz” in the figure
given above. As area “wxyz” internalize the area “wxy”, area “wxyz” is
greater than area “wxy”. This implies there is net gain to the society. The
gain to the society is represented by the area “wyz” as given in the figure
given above.