Monte owns a dog; the dog’s barking annoys Monte’s neighbor, Teresa. Suppose that the benefit of owning the dog is worth $200 to Monte and that Teresa bears a cost of $400 from the barking. Assuming Monte has the legal right to keep the dog, a possible private solution to this problem is that   a. Teresa pays Monte $150 to give the dog to his parents who live on an isolated farm.   b. Monte pays Teresa $350 for her inconvenience.   c. Teresa pays Monte $300 to give the dog to his parents who live on an isolated farm.   d. There is no private transaction that would improve this situation.

Consumers A, B, C, and D respectively have a willingness to pay of $130, $100, $80, and $50 for one widget. Firms W, X, Y, and Z each have capacity to produce one widget at respective costs of $10, $60, $90, and $110. If these are the only consumers and firms in this market, and there are no third party costs or benefits from widgets, what is the socially efficient quantity of widgets? 4 There is insufficient info to answer question 3 2

2. In this question we will combine a very simplified model of an externality that has long-lasting impacts with the model of discounted utility that we learned in our game theory topic. Consider a hypothetical environmental externality: produced as the byproduct of industrial activity, each unit of emission of a pollutant that is emitted once, today, causes $10 of external harm to society each and every year, starting immediately, forever. Let's say that policymakers apply a discount factor of 8 € (0, 1) to future gains and losses, in an analog of the discounted utility model except for cash payoffs rather than utilities. What would the socially efficient Pigouvian tax on the emission of this pollutant be if we applied a discount factor of (i) 8 = 0.5, (ii) 6 = 0.9, and (iii) 8 = 0.99? Give an intuitive explanation of how to interpret the parameter & in this context, and explain precisely but in simple terms what the goal and effect of the Pigouvian tax would be.

Suppose the government wants to reduce the total pollution emitted by three local firms. Currently, each firm is creating 4 units of pollution in the area, for a total of 12 pollution units. If the government wants to reduce total pollution in the area to 6 units, it can choose between the following two methods:   Available Methods to Reduce Pollution 1. The government sets pollution standards using regulation. 2. The government allocates tradable pollution permits.   Each firm faces different costs, so reducing pollution is more difficult for some firms than others. The following table shows the cost each firm faces to eliminate each unit of pollution. For each firm, assume that the cost of reducing pollution to zero (that is, eliminating all 4 units of pollution) is prohibitively expensive. Firm Cost of Eliminating the... First Unit of Pollution Second Unit of Pollution Third Unit of Pollution (Dollars) (Dollars) (Dollars) Firm X 130 165 220…