ECON/ARE 115A

Discussion Section Exercise 7 Name 1: ____________________________

Due November 23, 2010 (end of lecture) Name 2: ____________________________
Name 3: ____________________________
TA Name: ___________________________

Public Good Provision

The following problems are related to Public Good provision.

Consider a city such as L.A. with a lot of particulate pollution (small particles suspended
in the air). Besides being unpleasant to the eye, these particulates can lead to health
problems such as asthma and lung cancer. Suppose there are two representative agents in
L.A. each of which you, as governor, care about equally. How would you go about
finding the optimum level of air quality and how much to charge each agent to clean the
air?

To clean one unit of air, it costs the government 8. The demands for clean air of agent 1
and agent 2 are given by:

1. Plot and label on the space below the

- Marginal cost curve
- Agent demand curves
- Total demand curve
2. At the current market price for clean air. How much clean air would each agent
demand?

1
D1 = 5 − (8) = 1
2
1 1
D2 = 3 − (8) =
3 3

3. What is the socially optimal amount of clean air?

Since you need to sum vertically, convert to inverse demand curves before summing.
There is a kink in the aggregate demand curve, so we focus on the relevant side of the
demand curve.

Inverse demand curves:

P = 10 − 2 D1
P = 9 − 3D2
Aggregate inverse demand curve:
P = 19 − 5 D
Plug in the price and solve for aggregate demand:
8 = 19 − 5 D
11
D=
5

4. How much is each agent willing to pay for this amount of clean air

11 3
P1 = 10 − 2 D1 = 10 − 2( ) =5
5 5
11 2
P2 = 9 − 3D2 = 9 − 3( ) = 2
5 5

5. What would be the quantity of clean air if the government did nothing, and instead
each agent had to purchase clean air? (Note: assume you cannot purchase fractional
units of clean air.)

Agent 1 would purchase 1 unit of clean air (see question 2).

6. Where in this model is there a free rider problem?

If the government does not intervene, agent 2 will get value from the unit of clean air
purchased by agent 1, but will not pay for it.

7. What aspect of public goods makes them prone to the free-rider problem?

The benefits of public goods are not excludable – anyone can enjoy the benefits. It is not
possible to prevent agent 2 from enjoying the clean air purchased by agent 1.