Question

Pam and Kunal are the only members of a community that is trying to determine how much of a public good should be produced. Suppose that Pam is willing to pay $10 for the fourth unit of the public good and that Kunal is willing to pay $6 for the fourth unit. The marginal cost of producing the public good is constant at $4. Which of the following is true?

A) Fewer than four units of the public good should be produced.
B) Exactly four units of the public good should be produced.
C) The Lindahl equilibrium is established when the price of the public good is $10.
D) More than four units of the public good should be produced.

Answer 1

Exactly four units of the public good should be produced, given the willingness to pay and marginal cost.

Step-by-step explanation:

The correct answer is Option B) Exactly four units of the public good should be produced. In this scenario, Pam is willing to pay $10 for the fourth unit of the public good, while Kunal is willing to pay $6 for the fourth unit. The marginal cost of producing the public good is constant at $4.

To determine the optimal quantity of the public good, we compare the willingness to pay of individuals (represented by the market price) with the marginal cost of production. If the market price is greater than the marginal cost, society would benefit from producing more of the good. If the market price is less than the marginal cost, producing more of the good would result in a net loss for society.

In this case, the market price ($10) is greater than the marginal cost ($4), so there is a benefit to producing more units of the public good. However, since both Pam and Kunal are only willing to pay for four units of the good, producing more than four units would not generate any additional benefit. Therefore, the optimal quantity of the public good is four units.

Answer 2

D) More than four units of the public good should be produced

Step-by-step explanation:

Marginal cost refers to the additional cost incurred for an extra unit of a good produced.

A firm continues production till the point marginal profit is zero.

Marginal profit is the excess of marginal revenue over marginal cost.

Marginal revenue refers to the addition to total revenue when an additional unit of output is sold.

In the given case, marginal profit is positive under both the scenarios.

Thus, more than four units of public goods shall be produced until the point marginal profit is zero i.e marginal revenue = marginal cost.