Deck 18: The Theory of Second Best

Question 1

Consider a monopolist with a private MC of $20 per unit who faces a demand curve of P = 100 - q.There is also a negative consumption externality in the market of $40 per unit.What is the DWL in the market outcome?

A)DWL = $800
B)DWL = $1600
C)DWL = $200
D)DWL = $400
E)DWL = $0

Answer 1

DWL = $0

Question 2

Consider a monopolist with a private MC of $20 per unit who faces a demand curve of P = 100 - q.There is also a negative consumption externality in the market of $40 per unit.The government successively introduces competition into the supply side of the market, so now instead of a monopolist there are many price-taking firms.Which statement is true?

A)The government intervention increases the DWL in the market from 0 to $800.
B)The government intervention in the market decreases the DWL from $800 to $0.
C)The government intervention reduces but does not eliminate DWL in the market.
D)The government intervention increases DWL from $0 to $1600.
E)None of the above.

Answer 2

The government intervention increases the DWL in the market from 0 to $800.

Question 3

The Theory of Second Best suggests:

A)The government should only remove small market failures in the economy.
B)The government should never attempt to remove market failures in the economy.
C)Some market failures can help offset other market failures, increasing overall welfare.
D)All of the above.
E)None of the above.

Answer 3

Some market failures can help offset other market failures, increasing overall welfare.

Question 4

Consider a monopolist with a private MC of $20 per unit who faces a demand curve of P = 100 - q.There is also a negative consumption externality in the market of $40 per unit.What is the most appropriate policy response if the government wishes to maximize surplus in the market.

A)The government should implement a Pigovian tax of $40 on consumers.
B)The government should implement a Pigovian tax of $40 levied on the monopolist.
C)The government should subsidize production by $40 per unit.
D)Either a or B

Question 5

A lesson to policy makers from the Theory of Second Best is that:

A)Care is needed removing any one distortion in the economy, given the possible interaction between various distortions in the economy.
B)Total surplus will increase if all distortions can be simultaneously eliminated.
C)The largest market failures need to removed first.
D)a and B