Positive Externalities Exercise #1Key

Course Student Name: ______Course Number Section: ______University or College Professor’s Name

Positive Externalities Exercise #1 ( points)

Please limit your answers to the spaces provided. If necessary, write on the back of the page. Do not attach printout or additional pages. All questions pertain to the Externalities module in the SimEcon® software package.

Make sure that you have read the “Positive Externalities Manual” and “SimEcon® Operation Instructions.” These materials may be found at the Class Web site prior to beginning the exercise. For many of the exercise’s questions, it will be necessary to refer to those instructions. For many of the exercise’s questions, it will be necessary to refer to your text.

Open the Externalities module. You will arrive at the table entitled, “Flu Conditions: Effects of Flu and Flu Vaccine.” What is a positive externality? ______. In what manner can a flu vaccine represent a positive externality? ______.

Look at the initial table on your SimEcon® screen. What is the marginal social benefit of a flue shot? ______. What is the marginal private cost of a flu shot? ______. Is this equal to the marginal social cost of a flu shot? ______(Yes, No). Why or why not? ______. Is society at a socially optimum point? ______(Yes, No). Why or why not? ______. Notice the amount for “Social Net Benefits Lost.” What is that amount and what does it represent? ______.

Click “Continue.” You will see a graph entitled, “Influenza Vaccine Market.” In this graph, which is closer to the social optimum, monopoly (QM, the current situation) or competition (QC)? ______. Thus, would it be advantageous to promote competition in the distribution of flu vaccines? _____ (Yes, No). What is the difference between the marginal social benefit line and the D = MPB line? ______. Course Page 2 Positive Externalities Exercise #1

Click “Continue.” You will be asked to set the cost of developing the vaccine. Leave this at $500 and click “Market Structure.” Select “Create Competition” and click “Next Decision.”

Select “subsidize each vaccination.” You will be asked what portion of the market price that the government will pay. Enter 0.60 (60% in decimal form) and click “Continue.” A warning message appears on the screen. What does this message say? ______What is the usual impact of promoting a competitive industry on the market price? ______. Why is the industry making negative economic profit? ______. In this situation, in order to stimulate enough vaccine production, what must the government do? ______.

Click “OK.” You will see a results screen. What is the price of a flu shot in the competitive market? ______. What is the marginal social benefit of the current output? ______. What is the marginal social cost of the current output? ______. Is society at the optimal level of production? ______(Yes, No). If not, what must society do to production to reach the optimal level? ______. Click “See Graph” and draw the resulting graph that you see below. Label all axes and lines. Indicate the current and optimal levels of production. It is not necessary to include the average cost line.

If the government subsidizes a greater portion of the vaccine, what will happen to the marginal private cost? ______. Thus what will happen to the quantity produced under competition? ______. Click “New Value.” You will again be asked what portion of the market price the government will pay. Enter 0.90 (90% in decimal form) and click “Continue.” Even though the government is subsidizing 90% of the cost, does the same error message appear as before? ______(Yes, No). Course Page 3 Positive Externalities Exercise #1

Click “OK.” Repeat this process, only have the government subsidize 99% of the vaccination cost. Does the same error message appear? ______(Yes, No). What is the price of a flu shot in this situation? ______.

Would this market price of a flu shot have socially desirable outcomes for those people with low incomes? ______(Yes, No). In what manner would this outcome benefit the impoverished and the working poor? ______

After you have obtained the results screen for a 99% subsidy, click “See Graph.” Compare the current production under competition with the socially optimal quantity. Is society at the optimal level of vaccine production? ______(Yes, No). If not, what must society do to reach the optimal level of production? ______. Do these results indicate that in terms of strict economic value, a certain amount of sickness might be optimal? ______(Yes, No).

Note that in the current situation, the government is subsidizing 99% of the vaccine cost, and the competitive industry is incurring negative economic profit. What do these results indicate about the viability of a competitive market structure, given the current parameters? ______. Click “New Policy.” You will be asked to set the cost of developing the vaccine. Leave this at the default value of $500 and click “Market Structure.” Select “Create a Monopoly” and click “Next Decision.” Select “Subsidize Each Vaccination” and enter 0.60 (60% in decimal form). Click “Continue.” Does the error message appear this time? ______(Yes, No). What are the marginal social benefits under this regime? ______. What are the marginal social costs under this regime? ______. Is society at an optimal level of production? ______(Yes, No). If not, what must society do to reach the optimum? ______. Click “See Graph.” Is there now a big difference between current and the optimal levels of production? ______(Yes, No).

Consider another issue. What is the price of a flu shot in the current situation? ______. Compared to previous results, would such a policy be supported by people on welfare and the working poor? ______(Yes, No). Why or why not? ______. In the prior cases, were the firms earning negative economic profits? ______(Yes, No). Under monopoly, is the firm earning positive economic profits? ______(Yes, No). What would be the nature of the political struggle over how the government should manage the vaccination program? ______Course Page 4 Positive Externalities Exercise #1

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Click “New Value.” You will be asked how much of the vaccination is to be subsidized. Enter 0.99 (99% in decimal form) and click “Continue.” Click “See Graph.” Is the level of production above or close to the optimum? ______(Yes, No). What is the problem with allowing a monopoly to exist? ______

At this point, click “New Policy.” Leave the vaccination cost at the default value of $500 and click “Market Structure.” Click “Create Competition” and then click “Next Decision.” This time, select the button to subsidize the cost of development. You will be asked how much of the cost of development is to be subsidized. Enter $500 and click “Continue.” What is the price of the vaccine to the consumer and how many flu shots are given? ______. What is the economic profit in the competitive industry? ______. What are the marginal social benefits under this regime? ______. What are the marginal social costs under this regime? ______. Is society at an optimal level of production? ______(Yes, No). If not, what must society do to reach the optimum? ______. Click “See Graph” and observe the difference between the current and socially optimal level of production.

Should the government increase, decrease or leave the development subsidy unchanged? ______What do these results indicate about the effectiveness of this policy of subsidizing the cost of development? ______

What is the advantage of subsidizing development cost? ______.

Click “New Policy.” Leave the cost of development at the default value of $500 and click “Market Structure.” Select “Create a Monopoly” and click “Next Decision.” Select “Subsidize the Cost of Development.” Enter $500 and click “Continue.” What are the marginal social benefits under this regime? ______. What are the marginal social costs under this regime? ______. Is society at an optimal level of production? ____ (Yes, No). If not, what must society do to reach the optimum? ______. What is the price charged to consumers and how many flu shots are given? ______. What is the monopoly profit? __$562.50__. In this monopoly, did subsidizing development affect output? ______Course Page 5 Positive Externalities Exercise #1

______. Click “See Graph” and observe the difference between the current and socially optimal level of production.

Compare the results under competition and monopoly when 100% of the cost of development is being subsidized. Which regime provided the lower cost to the consumer? ______. Which regime resulted in more flu shots being given? ______. Remember that you observed the graphs for both of these regimes. Which regime had the smaller difference between marginal social benefits and marginal social costs? ______. Thus, even though neither regime was able to achieve the socially optimal level of production, which regime came closest to it? ______. Why is this the case? ______. Other things being equal, government should try to promote what type of market structure in the vaccine industry? ______.

Is there any way for the government to get the private market to produce near the social optimum? Yes (Yes, No). How can it accomplish that goal? ______.

What do the results in this assignment indicate about the nature of positive externalities? In other words, in the absence of government regulation and/or subsidy, will the socially optimal quantity of output be produced? ______(Yes, No). If not, will too much or too little be produced? ______.

How does the purchase of a good with positive externalities affect other individuals? ______. Will those other individuals have to pay for anything? ______The person who purchases the flu shot, what costs and benefits will he/she consider? ______. Thus, in the decision to purchase a flu shot, will all benefits be considered? ______(Yes, No). When an economic good or service produces a positive externality, is it in the interests of society, other things being equal, to increase production of that good or service? ______(Yes, No).