Topics: Economics, Externality, Marginal cost Pages: 8 (2154 words) Published: May 21, 2013
Situation 1: The motorcycle helmet market has 13 companies, and four firm concentration ratio of 26%. While the helmets have a variety of designs, they are sold at very similar prices. Recently, the death rate from head injuries in motorcycle crashes has been rising. The producers advertise their helmets as “effective,” but some helmets withstand most falls and others are produced with materials that are more likely to crack in commonly experienced falls. The weaker helmets cost about $8 less to produce. There is no simple way for consumers to determine helmet safety.

a) This is a case of market failure caused by externalities emanating from some production agents of the helmets producing lower quality hence weaker helmets while still pricing them at the same price level as the safer, higher quality helmets. This causes a high negative production externality as the consumers will eventually lump all helmets as unsafe, which will negatively affect the other companies as the consumers cannot determine easily the safety of the different brands of helmets. Thus, the consumers may opt to forego riding motorcycles altogether. b) Since the producing agents of the weaker helmets are only considering maximizing the profits at the expense of quality and safety, they do not take into consideration the social costs associated with the use of weaker helmets. Initially, the production agents for these weaker helmets will receive high marginal benefits than marginal costs due to the use of heaper production materials. However, the do not take into account the effect f the cost to society in the form of head injures and deaths resulting from the use of these helmets. The marginal benefit for the weaker helmets will be higher than the marginal costs hence the market will be allocating inefficient. The lower production cost and higher profits will create a false market supply which does not supply an incentive for better production methods. The market becomes inefficient due to the different marginal costs brought about by use of production materials of different qualities. c) Due to the lower cost of production of some helmets, the market will exhibit a higher productive efficiency without considering the social welfare. The productive efficiency curve will falsely show an outward extended production possibly frontier (PPF) which may lead to a false signal for increasing demand. This will remove the incentive to put in measures for better actual productive efficiency. d) The most effective government policy to correct this market failure would be imposition of additional selective taxes on the base materials used to manufacture the weaker helmets amounting to higher than $8, such that the marginal cost (MC) of the weaker helmet exceeds the marginal cost for the higher quality helmets. This policy will lead the manufactures opting to manufacture only the higher quality helmets hence increasing the social benefits acquired from increased safety, while at the same time without the associated costs of other quality control measures by the government. e) This government policy would try to provide incentive to make the market work better without overtly trying to change the production practices.


The marginal social cost (SMC) is higher than the marginal private cost (PMC). This leads to a reduction in the marginal social benefit with increase in production as brought about by use of the weaker helmets. Situation 2: In 2011, there was a combination of sharply increasing world demand for food and drought in many grain-producing areas. Wheat prices rose by 75% in one year. Many bread and pasta producers shut down or went out of business completely and consumers in many countries became hard pressed to feed their families. In addition, producers of beans and corn were unaffected by the drought, but also charged higher prices, earning higher profits. Many consumer...
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