Nanyang Technological University

HE9091 Principles of Economics

AY2012-2013 Semester 1
Tutorial 5
Question 1
Suppose the supply curve of boom box rentals in Golden Gate Park is given by
P = 5 + 0.1Q, where P is the daily rent per unit in dollars and Q is the volume
of units rented in hundreds per day. The demand curve for boom boxes is 20
0.2Q.
(a)
If each boom box imposes $3 per day in noise costs on others, by how
much will the equilibrium number of boom boxes rented exceed the socially
optimal number?
(b)
How would the imposition of a tax of $3 per unit on each daily boom
box rental affect efficiency in this market?
Question 2
Barton and Statler are neighbours in an apartment complex in downtown.
Barton is a concert pianist, and Statler is a poet working on an epic poem.
Barton rehearses his concert pieces on the baby grand piano in his front room,
which is directly above Statlers study. The following matrix shows the
monthly payoffs to Barton and Statler when Bartons front room is and is not
soundproof. The soundproofing will be effective only if it is installed in
Bartons apartment.
Gains to Barton
Gains to Statler

Soundproofed
$100/month
$120/month

Not soundproofed
$150/month
$80/month

(a)
If Barton has the legal right to make any amount of noise he wants and
he and Statler can negotiate with one another at no cost, will Barton install and
maintain soundproofing? Explain. Is his choice socially efficient?
(b)
If Statler has the legal right to peace and quiet and can negotiate with
Barton at no cost, will Barton install and maintain soundproofing? Explain. Is
his choice socially efficient?
(c)
Does the attainment of an efficient outcome depend on whether Barton
has the legal right to make noise, or Statler the legal right to peace and quiet?
Question 3
Consider the market for fire extinguishers.
(a)
If homeowners in housing flats own fire extinguishers, why might this
exhibit positive externalities? Draw a graph of the market for fire

extinguishers, labeling the appropriate curves. Indicate the market equilibrium

level of output and the socially optimal level of output. Give an intuitive
explanation for why these quantities differ.
(b)
If the external benefit is $10 per extinguisher, describe a government
policy that would result in the socially optimal outcome.
Question 4
Carols is risk neutral and has an ancient farmhouse with great character for
sale in Slaterville Springs. His reservation price for the house is $130,000.
The only possible local buyer is Whitney, whose reservation price for the
house is $150,000. The only other houses on the market are modern ranch
houses that sell for $125,000, which is exactly equal to each potential buyers
reservation price for such a house. Suppose that it Carlos does not hire a
realtor, Whitney will learn from her neighbor that Carlos house is for sale and
will buy it for $140,000. However, if Carlos hires a realtor, he knows that the
realtor will out him in touch with an enthusiast for old farmhouses who is
willing to pay up to $300,000 for the house. Carlos also knows that if he and
this person negotiate, they will agree on a price of $250,000. If realtors charge
a commission of 5% of the selling price and all realtors have opportunity costs
of $2,000 for negotiating a sale, will Carlos hire a realtor? If so, how will total
economic surplus be affected?