Principles of Economics 6th Edition

Frank Solutions Manual

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CHAPTER 13 THE ENVIRONMENT, HEALTH, AND SAFETY

Answers to Review Questions

1. Efficient resource use requires that the buyer pay a price equal to the marginal cost of the
resource. First-dollar health care coverage is inefficient because it violates this principle.
Specifically, policyholders are reimbursed for all medical expenses and thus face an effective
price of zero for medical care, while the marginal cost of medical services is clearly some
positive amount. This leads policymakers to use more medical care than is optimal.
Learning Objective: 13-01
AACSB: Reflective Thinking
Bloom’s: Understand

2. Efficient cleanup requires that the marginal cost of pollution reduction be the same for every
polluter. If this is not the case, it is possible to reduce the total cost of pollution reduction by
having polluters with high marginal costs remove less and those with low marginal costs
remove more. Pollution taxes and the sale of effluent permits result in marginal costs of
pollution reductions that are the same for all polluters. Across-the-board-cutbacks, in
contrast, result in marginal costs of pollution reduction that are higher for some firms than
others and thus result in inefficient cleanup efforts.

Learning Objective: 13-02

AACSB: Reflective Thinking
Bloom’s: Understand

3. Individuals tend to ignore the fact that if they are infected with a disease, this will impose
additional risks on others. Thus, if vaccinations are not a legal requirement for entry into
public schools, the equilibrium rate of vaccination will be below the optimal rate.

Learning Objective: 13-04

AACSB: Reflective Thinking
Bloom’s: Understand

4. The optimal number of bank robberies is that number for which the marginal cost of curbing
robberies is equal to the marginal benefit. Society has no interest in spending far more to
prevent a robbery than the loss the robbery would impose on society if it occurred.

Learning Objective: 13-04

AACSB: Reflective Thinking
Bloom’s: Understand

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5. Yes, it does it make sense for the Federal Aviation Administration to require more
sophisticated and expensive safety equipment in large commercial passenger jets than in
small private planes. Commercial jets carry many more passengers than small private planes,
so the benefit of preventing a commercial jet from crashing is far greater than the benefit of
preventing a private plane from crashing. The optimal amount of safety equipment is
therefore greater for the commercial jet than for the small, private plane.

Learning Objective: 13-04

AACSB: Reflective Thinking
Bloom’s: Understand

Answers to Problems

1. a. David will remain hospitalized for 8 days. With full coverage, David faces a marginal
charge of zero for additional days in the hospital, so he will stay until the marginal benefit of
staying in the hospital is equal to the marginal cost of staying in the hospital.

b. With insurance that covered only expenses greater than $1,000, he would face a marginal
cost of $150 per day, and would choose to stay in the hospital only 2 days. The cumulative
amount by which the extra cost of an 8-day stay exceeds the extra benefit will be $450, the
area of the darker shaded triangle in the diagram below. Thus, the six extra days cost society
$900, but benefit David by only $450. So total economic surplus would have been $450
higher under the policy that covers only those expenses beyond $1,000 per illness.

Price ($/day)
Benefit from additional stay
Lost surplus from
D additional stay
175
150

2 8
Length of hospital stay (days)

c. Under the new plan, the insurance company pays 50 percent of the cost of an additional
day in the hospital and David pays 50 percent. So David must pay (0.50) ($150) = $75 for
each additional day in the hospital. As shown in the diagram below, David will extend his
stay from 2 to 5 days under the new plan. The benefit of the additional 3 days to David is the
area of the light shaded figure, which is equal to (1/2)($75 per day)(3 days) + ($75 per day)(3

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 days) = $337.50. The total cost of the 3 additional days is $450, so the net change in total
surplus compared to the plan in (b) is $337.50 - $450 = -112.50.

Price ($/day)
Lost surplus from
additional stay

175 D Benefit from additional stay

150

75

2 5 8
Length of hospital stay (days)

Learning Objective: 13-01

AACSB: Analytic
Bloom’s: Analyze

2. a. See the diagram below. When consumers pay for their own procedures, they demand
40,000 of them per year, and the economic surplus they receive is equal to the area of the red
shaded triangle, which is $20,000,000 per year. When the procedures are fully covered, they
demand 80,000 of them per year. Each of the 40,000 additional procedures costs $1,000 to
perform, but the value to consumers for each additional procedure (as indicated by the
corresponding willingness to pay value on the demand curve) is less than $1,000.
Cumulatively, the cost of the additional procedures exceeds their value to consumers by the
area of the blue shaded triangle, which is also $20,000,000 per year. This is the reduction in
total surplus caused by making the procedure fully reimbursable.

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 Price of rhinoplasty
($/procedure)
2000 Lost economic
surplus

1000

1000s of procedures
40 80 per year

b. If health insurance covers $500 of the cost of the procedure, the remaining $500 of the
procedure’s $1000 cost will be the price seen by consumers, who will demand a total of
60,000 procedures per year. The lost economic surplus will be the area of the blue shaded
triangle, which is $5,000,000 per year.

Price of rhinoplasty
($/procedure)
Lost economic
2000 surplus

1000

500

1000s of procedures
40 60 80 per year
Learning Objective: 13-01
AACSB: Analytic
Bloom’s: Analyze

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This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
3. a. If pollution is unregulated, both firms will use process A and emit 8 tons per day.

b. To reduce emissions by 50 percent, both firms must switch to process C. The cost will be
$120 - $50 = $70 for Sludge Oil and $500 - $100 = $400 for Northwest Lumber, for a
total cost of $470.

c. Each firm will switch to a cleaner process if the cost of doing so is less than $T. If T =
$81, Sludge Oil finds it worthwhile to switch from process A to B, and still finds it
worthwhile to switch from process B to C, and again from C to D. Northwest Lumber
finds it worthwhile to switch from process A to B. Sludge Oil thus cuts emissions by 3
tons, and Northwest Lumber by 1 ton. The total cost to society is $200 - $50 + $180 -
$100, or $230.

Learning Objective 13-02

AACSB: Analytic
Bloom’s: Analyze

4. If Sludge Oil does not have any permits it will have to pay $500. Sludge Oil is therefore
willing to pay up to $300 for the first permit, which is the cost difference between process E
and process D. Sludge will pay up to $80 for the second permit, and so on. If Northwest
Lumber does not have any permits it will have to pay $2,000. Northwest Lumber is therefore
willing to pay up to $1,000 for the first permit, which is the cost difference between process
E and process D. Northwest will pay up to $500 for the second permit, up to $320 for the
third, and up to $80 for the fourth. Therefore, the auction price will keep rising until it
reaches $81, the lowest price for which the total demand is 4 permits. Sludge Oil will buy 1
permit and Northwest Lumber will buy 3 permits. The total cost of the pollution reduction is
$230. Sludge Oil now pays $200 instead of $50, and Northwest Lumber pays $180 instead
of $100.

Learning Objective 13-02

AACSB: Analytic
Bloom’s: Analyze

5. No, Tom and Al will not choose optimally between the two jobs? The socially optimal
situation is for both to choose a safe job, since each gets a total benefit of $100 (from wages)
+ $40 (from safety) = $140 per week. This is $10 per week more for each man than the total
benefit when each takes the risky job. However, when Tom chooses the safe job and Al
chooses the risky job, Tom’s payoff is $100 + $40, minus the cost of earning less than Al,
$30. This makes Tom’s payoff only $110. In contrast, Al has the satisfaction of earning
more than Tom, so he gets $130 salary, plus a $30 satisfaction payoff, or $160 per week of
value. Since the situation is symmetric, these payoffs are reversed if Al has a safe job and
Tom has a risky job. The payoff matrix for these players and strategies is therefore:

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 Tom
Safe job @ $100/wk Risky job @ $130/wk

$110 for Al
Safe job
$140 each
@ $100/wk $160 for Tom
Al
Risky j ob $160 for Al
$130 each
@ $130/wk $110 for Tom

Choosing the risky job is the dominant strategy for both people, so both Tom and Al will
choose the risky job, which is not the socially optimal choice.

Learning Objective: 13-03

AACSB: Analytic
Bloom’s: Analyze

6. If Tom and Al could negotiate at no cost, they would enter a binding agreement to work in
the safe job since each of them would be $10 per week better off than if each followed his
dominant strategy. However, the total gain in surplus from choosing the safe job is only $20
per week, so safety regulations that cost $25 per week to enforce would not be an attractive
proposition.

Learning Objective: 13-03

AACSB: Analytic
Bloom’s: Analyze

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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.