Free-Response Question

1. Question

   Suppose there are 100 residents on the island of Mahalo. Whenever someone purchases a palm tree to plant on the island, everyone on the island receives the same benefits from the tree, which include beauty, shade, and erosion control. The table above shows the total social cost (which is also the total private cost) and the total private benefit received per resident depending on the quantity of palm trees purchased. Use this information to answer the questions below.

   
   

   
   

   1. Does the purchase of palm trees create a negative externality, a positive externality, or no externality? Explain.

      
      
   
   

   2. Draw a graph that depicts the marginal social cost and the marginal social benefit of palm trees.

      
      
   
   

   3. What quantity of palm trees would be purchased if they were sold in a private market? Explain.

      
      
   
   

   4. What is the socially optimal quantity of palm trees? Explain.

      
      
   
   

   5. In this situation are palm trees a private good, a public good, or a common resource?

      
      
   
   

   6. What could be an appropriate governmental policy response to this situation? Explain.(10 points)

      
      
   
   
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   Rubric for FRQ (10 points)

   1 point: A positive externality

   1 point: Every palm tree provides benefits to the purchaser and 99 other people, so the marginal social benefit is 100 times the marginal private benefit. The benefits that spill over to other people constitute a positive externality.

   1 point: Graph with “Marginal social benefit, marginal social cost” or “$ per unit” on the vertical axis, “Quantity of palm trees” on the horizontal axis, and a downward-sloping marginal social benefit curve

   1 point: Horizontal marginal social cost curve at a level of $200

   1 point: Zero palm trees would be purchased in a private market because the most an individual would pay for a palm tree is $8, and in the private market the price would be at least $200, which is the marginal cost of producing palm trees.

   1 point: The socially optimal quantity of palm trees is 3.

   1 point: It is with the purchase of 3 palm trees that the marginal social cost equals the marginal social benefit.

   1 point: In this situation, palm trees are a public good—everyone enjoys the benefits of each palm tree, so consumption is nonrival and nonexcludable.

   1 point: A subsidy or direct government provision of the public good 1 point: A subsidy could bring the marginal private benefit up to the level of the marginal social benefit, or government provision of a public good could solve the free-rider problem.