Question #1: Externalities [12 Points] Dunder-Mifflin produces paper. One of the by-products of paper production is paper sludge which seeps into the local river and kills the most forms of aquatic life. (@) In the above scenario the production of paper is an example of what type of externality? [2 Points] (b) Draw a graph showing the externality. Label the axes. Clearly label the following curves: private value curve, private cost curve, social value curve and social cost curve. In your graph, label the market equilibrium as Point "A" and label the socially optimal equilibrium as Point "B". [6 Points] (c) At the market equilibrium is Dunder-Mifflin producing too much or too little paper? Explain your answer. [2 Points] (d) Suggest a policy that could be implemented that would get Dunder-Mifflin to produce the socially optimal amount of paper. [2 Points] Question #2: The Costs of Production [14 Points] Palpatine runs a facial cream business. He can make 100,000 bottles of facial cream per year and sell them for $3.50 each. It costs Palpatine $250,000 for the raw materials to produce the facial cream. Additionally, he must pay $30,000 annually to rent the factory needed to produce his cream. In order to start his business Palpatine withdrew $200,000 from his own savings account. The bank is currently paying a 3% interest rate on saving accounts. Before Palpatine opened his business he worked as a political consultant where he earned $80,000 per year. (a) What is the total revenue Palpatine earns in a year? [2 Points] (b) What are the explicit costs Palpatine incurs while producing bottles of facial cream? [2 Points] (c) What are the implicit costs Palpatine incurs while producing bottles of facial cream? [2 Points] (d) What is the amount of Palpatine's accounting profit? [2 Points] (e) What is the amount of Palpatine's economic profit? [2 Points]Question #2: The Costs of Production [14 Points] Palpatine runs a facial cream business. He can make 100,000 bottles of facial cream per year and sell them for $3.50 each. It costs Palpatine $250,000 for the raw materials to produce the facial cream. Additionally, he must pay $30,000 annually to rent the factory needed to produce his cream. In order to start his business Palpatine withdrew $200,000 from his own savings account. The bank is currently paying a 3% interest rate on saving accounts. Before Palpatine opened his business he worked as a political consultant where he earned $80,000 per year. (a) What is the total revenue Palpatine earns in a year? [2 Points] (b) What are the explicit costs Palpatine incurs while producing bottles of facial cream? [2 Points] (c) What are the implicit costs Palpatine incurs while producing bottles of facial cream? [2 Points] (d) What is the amount of Palpatine's accounting profit? [2 Points] (e) What is the amount of Palpatine's economic profit? [2 Points] Page 1 of 5 (f) Suppose Palpatine's former boss offers to pay Palpatine double his former salary if he were to rejoin the political consulting business. What effect will this offer have on the accounting profit for Palpatine's facial cream business? What will happen to economic profit? [4 Points]
