Eco200: Practice Test 2 Worksheet With Answer Key - Covering Chapters 10 Through 15 printable pdf download

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Eco200: Practice Test 2

Covering Chapters 10 through 15

1. Four roommates are planning to spend the weekend in their dorm room watching old movies, and they

are debating how many to watch. Here is their willingness to pay for each film:

Orson

Alfred Woody

Ingmar

First film

Second film

Third film

Fourth film

Fifth film

Within the dorm room is the showing of a movie a public good? Why or why not?

b. If it costs $ to rent a video, how many videos should the roommates rent to maximize total

surplus?

If they choose the optimal number from part (b) and then split the cost of renting the videos

equally, how much surplus does each person obtain from watching the movies?

d. Is there any way to split the cost to ensure that everyone benefits? What practical problems does

this solution raise?

Suppose they agree in advance to choose the efficient number and to split the cost of the videos

equally. When Orson is asked his willingness to pay, will he have an incentive to tell the truth? If

so, why? If not, what will he be tempted to say?

What does this example teach you about the optimal provision of public goods?

Solution: A Chapter 11 problem…

Within the dorm room, the showing of a movie is a public good. None of the roommates can be

excluded from viewing the movie. Because one roommate’s viewing does not affect the ability of

another roommate to view the movie, the good is also nonrival in consumption.

b. The roommates should rent three movies because the value of the fourth film ($6) would be less than

the cost ($8).

The total cost would be $8 × 3 = $24. If the cost were divided evenly among the roommates, each

would pay $6. Orson values three movies at $18 so his surplus would be $12. Alfred values three

movies at $12 so his surplus would be $6. Woody values three movies at $6, so his surplus would be

$0. Ingmar values three movies at $3 so his surplus is -$3. Total surplus among the three roommates

would be $15.

d. The costs could be divided up by the roommates based on the benefits they receive. Because Orson

values the movies the most, he would pay the greatest share. The problem is that this gives each

roommate an incentive to understate the value of the movies to him.

Because they are going to pay equal shares, Orson has an incentive to tell the truth about the value he

places on movies to ensure that the group rents three movies. He values each of the movies more than

his cost per movie ($2).

The optimal provision of public goods will occur if individuals do not have an incentive to hide their

valuation of a good. This means that each individual’s cost cannot be related to his valuation.

Eco200: Practice Test 2 Worksheet With Answer Key - Covering Chapters 10 Through 15