Problem Set 5 - Externalities and Efficiency Assignment

Problem Set 5 - Externalities and Efficiency - Assignment Example Use a supply and demand diagram to illustrate your answer and provide no more than five sentences of explanation. When prices are set below the equilibrium, i.e P2, there will be an increased demand in the houses by the population. Since supply remains constant as demand rises, there will be a shortage in the short run. However, in the long run, people will tend to build their own houses or property owners will develop more to avoid the shortages. This increases the supply of the houses and reducing shortages. (Figure: Market for Vaccines) The figure represents the market for vaccines with external benefits. The efficient level of output is __1,800______ vaccines, which is ___greater_____ than the markets output. 5. Suppose Tesco (A) and Sainsbury’s (B) both emit pollutants when producing their plastic bags used by customers to collect and carry their groceries home. The government enforces regulations saying that neither firm can release more than 10 units of pollutants. (Assume that pollutants can be measured in discrete and comparable units.) Currently Tesco releases 10 units and Sainsbury’s releases 11 units. The government requires Sainsbury’s to reduce its pollution by 1 unit – the company can do this, but at a cost of  £1,000. Tesco, however, can reduce its pollution by 1 unit for a cost of  £400. Sainsbury’s wants to save money by trading allowances with Tesco. After negotiations, Tesco agrees to see one unit of pollutant to Sainsbury’s for  £650. From the diagram, P1 and Q1 are the equilibrium price and quantity respectively. In the short run the time is too short for firms to adjust production. However, in the long run, firms will increase output to Q2 and charge high price P2 due to an increase in shock demand. This leads to demand curve to shift from D1 to D2. This will make the firms to make abnormal profits. Since there is free entry, the excess profits will attract more firms into the market.