Assignment 6 – The Last Assignment
1- [This question is NOT about market failure; 35 points]
The pandemic has affected many sectors of the economy through supply and demand
shocks (things that shift supply and demand). For example, automakers have experienced
positive demand shocks because many consumers now prefer private modes of
transportation to public transportation. And they have also experienced negative supply
shocks primarily because of an increase in their inputs’ prices (e.g., workers, computer
chips, raw materials, etc.).
a- Show the impact of supply and demand shocks on the equili
ium of the market for cars
[5p].
- Suppose that we know that the price of cars has, on average, increased by 5000$ since
the pandemic started. Can this information help us to compare the magnitude of the supply
and demand shocks (i.e., whether the supply or the demand shocks are bigger or more
dominant)? Why or why not? You can refer to the graph you drew in part (a), or you can
draw new diagrams if you feel like it [10p].
c- Suppose that we know that the total revenue of automakers has increased since the
pandemic started. Can this information help us to compare the magnitude of the supply and
demand shocks? Why or why not? What additional information do we need in order to reach
a more conclusive answer? Draw as many new diagrams as you feel you need in answering
this part of the question. Be as precise as possible [20p].
2- [Market Failure – 40p]
What is market failure? Explain the four types of market failure that we discussed in class.
For each case, refer to two examples and determine the difference between the size of free
markets and socially desirable levels. Use only words; no need to draw supply and demand
diagrams.
3- [Externalities – 25p]
a- Use supply and demand diagrams to show that, in the presence of negative externalities
(e.g., polluting industries), free markets are inefficient, i.e., they could result in a lower social
surplus compared with markets in which governments play active roles [10p].
- Discuss the similarities and the differences between “Cap and Trade” and “Ca
on Tax”
in controlling polluting industries. What factors affect the effectiveness of these policies in
limiting pollution? Use the appropriate diagrams that were discussed in class in answering
these questions [15p].