Pat would pay up to $7 for a fish sandwich. Alex owns a fish sandwich shop and c
ID: 1120706 • Letter: P
Question
Pat would pay up to $7 for a fish sandwich. Alex owns a fish sandwich shop and can produce a fish sandwich for a marginal cost of $5.
(a) If a regulation prevented Pat from buying the sandwich from Alex, what would be the deadweight loss?
(b) What is the largest tax that the government could impose without preventing Pat and Alex from trading with each other?
(c) Now suppose that Kerry lives next door to Alex and does not like the smell of fish. In fact, Kerry would be willing to pay up to $k to get Alex not to make the fish sandwich. What is the dollar value of the total benefits to society if Alex sells Pat a sandwich? What are the total costs? What are the net benefits (i.e. the total benefits minus the total costs)?
(d) For what values of k are the net benefits positive? For what values are the net benefits negative?
(e) Suppose a benevolent social planner wished to make sure that Alex sells Pat a sandwich if and only if the net benefits to society are positive. Would a tax of $k on the production of fish sandwiches accomplish this? Why?
Explanation / Answer
A) If a regulation prevented pat from buying the sandwich from alex then deadweight loss would be equal to cost of making fish sandwhich i.e $5.
B) The largest tax that the government could impose without preventing Pat and alex trading with each other is equal to $2(7-5).
C) if alex sales sandwhich to pat then
total benefit to society is $7.
Total cost is $5
Net benefit to society = $7 - $5= $2
D) if k>5 then net benefits are positive. And if k<5 then net benefits are negative.