9781118041581

Summary 493

b. Suppose the council increases the value of a life to $7.2 million. How

does the value placed on a life influence the council’s budget

allocation? Explain briefly.

Discussion Question In the aftermath of the September 11 terrorist attacks

in New York City and Washington, D.C., there has been renewed concern

about airport security. To date, security services at major airports have been

provided by a small number of private firms under contract with the airlines.

a. Many commentators and policy makers have argued that airport security

should not be left as the responsibility of private firms. Identify the

possible sources of market failure (if any) that might lead to security

standards that are too weak. What kinds of economic information could

one gather as evidence for or against market failure?

b. Supposing that a strong case for market failure were made, what are the

possible remedies? How could one apply benefit-cost analysis to craft the

most effective remedy? In answering questions (a) and (b), a first step is

to gather relevant information concerning the economics of airport

security from the business press and online.

Spreadsheet Problem

S1. Consider once again the combination of market failures outlined in

Problem 3. Recall that the demand for wood pulp is described by P 

500 10Q, where Q is measured in thousands of units. The long-run

cost of production exhibits constant returns to scale: LAC LMC 150.

Producing a unit of wood pulp generates one unit of pollution, and the

marginal external cost is estimated to be 100 per extra unit of pollution.

a. Create a spreadsheet similar to the one shown to model this setting.

In the spreadsheet, cells B10, C10, and D10 contain numerical values.

The entries in rows 15 and 19 and cell E10 are computed by formulas

linked to the numerical cells. Hints:Remember that consumer surplus

is found by using the formula for the area of a triangle, in this case:

.5*(500-E10)*B10. Total benefit is the sum of consumer surplus, net

profit, and government tax revenue minus the external costs

associated with pollution.

b. Using the spreadsheet, confirm the output and price results for each

of the analyst’s recommendations in Problem 3. Then find the

optimal regulatory policy using the spreadsheet’s optimizer. That is,

maximize total benefit by adjusting the output and tax cells.

c. Now suppose that the wood pulp producers can clean up part or all of

their pollution at a cost. The total cost of cleaning up u units of

pollution is 5u^2 ; that is, it increases quadratically. By cleaning up

pollution, producers avoid any tax. Thus, the government’s tax

c11RegulationPublicGoodsandBenefitCostAnalysis.qxd 9/29/11 1:34 PM Page 493