1. Illustrate the effects of a subsidy on good X with particular reference to
a. the effect on consumer choices
b. the amount of compensating variation
c. the cost of the subsidy to government
d. the resulting deadweight loss.
2. Explain why the amount of compensating variation associated with a subsidy on good X can be measured as the relevant area under the compensated demand curve for good X. In the same diagram, show that the cost of the subsidy exceeds the amount of compensating variation and illustrate the resulting deadweight loss.
3. (a) Use an Edgeworth Exchange Box diagram to illustrate a reallocation that is potentially Pareto improving. Explain why any point on the contract curve may be viewed as being potentially better (in the sense of Pareto improving) than any point off it.
(b) Within a production possibilities diagram illustrate an allocation that satisfies all three efficiency conditions. Explain why production efficiency is satisfied.
4. (a) State the three efficiency conditions (Pareto Conditions).
(b) Suppose MRSXY = 5 and MRTXY = 4. What does each of these values represent and what reallocation of X and Y will bring about a Pareto improvement? Explain.
5. (a) Provide two justifications for public provision of a private good such as health care and education. Explain.
(b) What is meant by the free rider problem in the context of the optimal provision of a public good?
State the case for public provision of a public good. Why would private provision of a public good result in a violation of the Samuelson condition? Why would an optimal subsidy ensure that the Samuelson condition is satisfied with private provision of a public good?
6. (a) Provide three arguments in favour of subsidization of public transit.
(b) In terms of the overall efficiency condition, explain why this is a situation in which there is a case for setting price below marginal cost (let x be public transit and Y be private automobile trips).
7. In a peak-load pricing situation, explain why, at the optimal capacity, peak users would pay a price in excess of long-run marginal cost whereas off-peak users would pay a price equal to marginal operating costs