Suppose that the inverse market demand curve for cloth is P  = 140 ? 2Q, the private marginal cost is MCp   = 65 + Q, and the private marginal damage for pollution is MCd   = 2Q

a.  What is the unregulated competitive equilibrium quantity and price? (10 marks)

b.  What is the social marginal cost of production and social equilibrium quantity and price? (10 marks)

c.  Graphically represent both equilibrium: (a) and (b) (10 marks)  [Total 30 marks]

Question 2

Leaving for holidays, Emma’s luggage may be lost with probability p  = 0.1. The luggage and its content are estimated to be worth ￡316.05. Emma’s utility function over monetary payoffs is given byu(x) = √x. Suppose Emma can insure against the loss of the luggage, what is the maximum insurance premium that Emma would be willing to pay? (20 marks). Using a diagram show and explain that a risk loving individual would decline the offer of full insurance coverage on actuarially fair terms (10 marks).  [Total 30 marks]

Question 3

Two neighbouring farmers must each decide whether to contribute to a fence that separates their properties. The fence costs a total of ￡20. Both farmers currently have a profit of ￡30 each. With a fence to keep each farmer's animals from wandering onto the  other's property, both farmers would experience a ￡15 rise in profits.

a.  Discuss the possible outcomes (20 marks).

b.  Explain whether social preferences can play any role in designing an institution to sustain cooperation (20 marks).  [Total 40 marks]