1. Suppose you live in neighborhood of 30 houses with a mean value of $50,000 (PE = $50,000 QE = 30). Your neighbor has just put new landscaping in and re-sided his home. His home improvements have made the neighborhood a better place to live for everyone and increased the value of the homes around him. The external benefit his improvements have made equals $1000.
a. What type of externality is occurring here? Using a graph, show how the free market fails at allocating the efficient quantity of homes. Label the appropriate area that shows the efficiency/inefficiency of the market. Is the market over or under producing in this situation? Explain. (Estimate a new price and quantity)
b. Would it be appropriate to use a pigovian tax or pigovian subsidy to decrease the inefficiency in the market? Explain your choice. How much would the tax/subsidy be?