Question

5. Suppose the demand for flu shots can be described by the inverse function P=80-Q and the inverse supply curve is given as P=8+2Q. What is the market equilibrium price and quantity in this market? Suppose that flu shots generate consumption externalities such that the marginal social benefit is given by the equation MSB=80 - 12Q. What are the values of Price and Quantity that maximize social welfare/surplus? Is there over- or under consumption of flu shots? What is the size of the deadweight loss? Suppose the government were to "correct” the market. Would they pursue a tax or a subsidy? What tax-level or subsidy-level would correct the market?

Answer 1

Answer:

Market equilibrium occurs where MPB = MPC (private demand = private supply)

80 - Q = 8 + 2Q

72 = 3Q

Q = 24 units

P = $56 per unit

There are positive consumption externalities so that MSB = 80 - 0.5Q

Socially efficient equilibrium has MSB = MPC

80 - 0.5Q = 8 + 2Q

72 = 2.5Q

Q = 28.8 units

P = $65.60 per unit

Under consumption since socially efficient quantity is more than private quantity

DWL = 0.5*(68 - 56)*(28.8 - 24) = $28.80

For this case there should be a subsidy because there is an underconsumption and production and consumption should be encouraged

Size of the subsidy = difference in MSB and MPB at social quantity = 65.60 - 51.20 = $14.40 per unit

Dollars 0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 64 68 72 76 80 Quantity MPB MPC --MSB