Externalities | Economics homework help

Externalities

 

 

Education is an example of a positive externality: acquiring more education benefits the individual student and having a more highly educated work force is good for the economy as a whole.

 

 

 

The accompanying table illustrates the marginal benefit to Sian per year of education and the marginal cost per year of education. Each year of education has a marginal external benefit to society equal to $8,000. Assume that the marginal social cost is the same as the marginal cost paid by an individual student.

 

 

 

Quantity of Education

(in years)

Sian’s Marginal Benefit

per year

Sian’s Marginal Cost

per year

9

10

$20,000

$15,000

11

19,000

16,000

12

18,000

17,000

13

17,000

18,000

14

16,000

19,000

15

15,000

20,000

16

14,000

21,000

17

13,000

22,000

 

 

 

 

 

  1. Find Sian’s market equilibrium number of years of education

 

 

 

  1. Calculate the marginal social benefit schedule

 

 

 

Years of Education

Sian’s marginal benefit per year

Marginal external benefit to society

Marginal social benefit

Sian’s marginal cost per year

9

10

$20,000

$8,000

 

$15,000

11

19,000

8,000

 

16,000

12

18,000

8,000

 

17,000

13

17,000

8,000

 

18,000

14

16,000

8,000

 

19,000

15

15,000

8,000

 

20,000

16

14,000

8,000

 

21,000

17

13,000

8,000

 

22,000

 

 

 

 

 

  1.  What is the socially optimal number of years of education?

 

 

 

  1. You are in charge of education funding. Would you use a Pigouvian tax or a Pigouvian subsidy to induce Sian to choose the socially optimal amount of education?  Justify your answer.

 

 

 

  1. How high would you set this tax or subsidy per year of education? Justify your answer.

 

 

 

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