Question

(30 points in total, 5 points each) Two workers share an office. Imagine the days smoking is allowed inside the buildings. Bill likes to smoke cigars and has a daily demand curve for cigars given by Q = 14 – P. He can buy all the cigars he wants for $2 each. His office mate Jim suffers harm and annoyance from the cigar smoke with the marginal cost to him given by 2Q. Use both a graph and an algebraic solution to answer the following questions: a. If there are no prohibitions on smoking in the office, how many cigars per day would Bill smoke? That is, what level of smoking maximizes Bill’s consumer surplus? b. What is the allocative efficient number of cigars for Bill to smoke each day? Be specific about your definition of allocative efficiency. c. Illustrate and calculate the difference in welfare between the answer to part (a) and part (b). d. Is the harm caused to Jim equal to zero at the efficient cigar level? e. If there were no prohibitions on smoking in the office, what does the Coase Theorem tell us about the likelihood Bill would smoke the efficient number of cigars? f. How would you answer to part (E) be altered if the workplace rules were changed to require a smoker to have their office mate’s permission before they could smoke in the office?

Answer 1

Answer:

Given that

Two workers share an office bill likes to smoke cigars and has a daily demand curve for cigars.

Given,

demand Q = 14 - P

supply price = $2

externality cost = 2Q

(a) If there are no prohibitions on smoking in the office, how many cigars per day would Bill smoke? That is, what level of smoking maximizes Bill’s consumer surplus?

In case of number of prohibition

  

  

  

   $2

(b) What is the allocative efficient number of cigars for Bill to smoke each day? Be specific about your definition of allocative efficiency.

In case of allocative efficient the cost of internality needs to be taken into decount

Here,

  

    

  

  

  

  

   $

(C) Illustrate and calculate the difference in welfare between the answer to part (a) and part (b).

Q falls from 12 to 4.

* Price increase from $2

* So, Consumer welfare falls

(d)Is the harm caused to Jim equal to zero at the efficient cigar level? e. If there were no prohibitions on smoking in the office, what does the Coase Theorem tell us about the likelihood Bill would smoke the efficient number of cigars?

No, its just that, now the cost to jim is minimized.

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