Question 22

Application 2 (20 points)Consider the following social welfare function:

SW=Ua(Xnca, Xca, Xc~a, Pa)+Ub(Xncb, Xcb, Xc~b, Pb)+ Ud(Xncd, Xcd, Xc~d, Pd)+...

Where: X=consumption bundle, P=pollution, nc=non-competitive, c=competitive

a, b, d = people; ~a, ~b, ~d = all other people besides a, b, d.

1. Will an overall increase in the level ofnon-competitiveconsumption always increase social welfare, explain why (2 points)? How social welfare will be affected by an increase in the level ofcompetitiveconsumption for a few (2 points)? How social welfare will be affected by an increase in the level of overall pollution (2 points)?

2.Let Xcbbe a new house overlooking a canyon. Let P be the reduction in scenic beauty experienced by the community. Finally, let Xc~bbe the status impact on folks who are not b arising from the new McMansion. Assume that the positive increment to individual utility for individual b of an increase in Xcbequals $20,000 in consumer surplus; and thatthe negative status increment to other people is -$1000.Assume also that a one unit increase in Xcbproduces one unit of "P", which further causes a -$2000 unit impact on utility for everyone exposed.In a world of 5 people (including Mr. b), what are the private benefits to Mr. b of consuming one more unit of Xcb(2 points)? What are the external costs of a one unit increase in Xcb(4 points)? What will be the net increase in SW of a one unit increase in Xcb(4 points)?

3. What parts the development decision in part #3 would a conventional benefit-cost analysis capture (2 points)? What would it miss and why (2 points)?