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Question - Suppose that the supply curve (private marginal cost) for a manufactured good is given by QS = 2P - 2 and that the demand for the product is given by QD = 7 - P.
a. Find the price and quantity in market equilibrium.
b. Suppose there is a negative externality associated with production, with damages given by MD = Q/2. What is the optimal quantity of Q for society to produce and consume? How much higher or lower is this than the market equilibrium quantity?
c. If society allows the market outcome (as opposed to requiring the optimal Q) how much loss is there in total social welfare?
d. Suppose we instead impose a policy that limits production of Q to a maximum of 1 unit. Assume as usual that price is given by the demand curve. What is the total social surplus? How does the distribution of this surplus differ when compared to the market outcome in part a (identity winners and/or losers from this policy relative to the market outcome)?
Question: Explain why the free rider problem makes it difficult for perfectly competitive markets to provide the Pareto efficient level of a public good.
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Read the rules of the game, the overview and the almanac for the Development Game "Settlers of Catan"
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