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Problem Set 5

Economics

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Problem Set 5.pdf - Adobe Acrobat Reader DC X File Edit View Sign Window Help Home Tools Problem Set 5.pdf x ? Sign In T 2 / 3 + 125% 8) [9 points total] Southern California Edison provides electricity to homes and businesses in the Los Angeles region. The company's distribution system includes approximately 50,000 miles of overhead power lines. Overhead power lines are a major risk factor for wildfires. The Getty fire that is currently burning in Los Angeles started when a tree branch fell on a power line, creating a spark that then ignited the dry brush underneath. Burying power lines underground is an example of a pure public good because it reduces the risk of wildfires that destroy property and often kill people. The benefit of reduced risk is nonrival because once the line is buried, it is costless for another person to benefit from the reduced risk. It is also nonexcludable because people in the vicinity benefit from the reduced risk even if they didn't pay for the line burial. Suppose that the benefit of burying power lines is different for those who own property vs. those who do not. The benefit to those who own property, expressed in billions of dollars, is given by B1 = 30 - 0.03Q2 La Page 2 of 3 Pa M 9 W 4:35 PM 10/17/2020

Where Q is the miles of buried lines measured in thousands of miles. Property owners’ marginal bene?t is given by M31 = 3 — 0.06Q. For those who do not own property, the bene?t is half as large. It is given by 32 = 1.5Q — 0.01502. This group’s marginal bene?t is MBZ = 1.5 — 0.03Q. Burying power lines is also very expensive. It generally costs at least $1 million per mile, and it costs much more than that in hilly or otherwise challenging terrain. Assume that the marginal cost of burying power lines, also expressed in billions of dollars, is constant and given by M C = 1.8 which implies that total cost is simply proportional to Q: TC = 1.8Q.

Problem Set 5.pdf - Adobe Acrobat Reader DC X File Edit View Sign Window Help Home Tools Problem Set 5.pdf x ? Sign In 3 / 3 + 125% a. [2 points] What is the efficient number of miles that should be buried? b. [2 points] In a well-labeled graph with quantity on the horizontal axis and price on the vertical axis, show your answer to part a. The graph should include each group's marginal benefit curve, social marginal benefit, and marginal cost. It should also be evident how those curves can be used to identify your answer from part a. c. [2 points] What is the deadweight loss if Q = 0 (i.e., if no overhead power lines are buried)? Denote it in your graph from part b, and also provide its numerical value. d. [2 points] What is the deadweight loss if Southern California Edison buries all 50,000 miles (i.e., if Q = 50)? Denote it in your graph from part b, and also provide its numerical value. Using the earlier formulas for B, and B2, burying all 50,000 miles would yield property owners $75 billion in benefits (i.e, B1 = 75 when Q = 50) and non-property owners $37.5 billion (i.e., B2 = 37.5 when Q = 50). It would cost $90 billion to bury all 50,000 miles (i.e., TC = 90 when Q = 50). The net benefit of burying all 50,000 miles is therefore 75 + 37.5 - 90 = $22.5 billion. e. [1 point] An administrator at Southern California Edison is trying to get permission to raise electricity prices in order to bury all 50,000 miles of overhead power lines. The administrator argues that since the net La benefit of burying all 50,000 power lines is positive, it is the economically efficient thing to do. Briefly explain to the administrator (who did not go to USC Price) why that logic is wrong, and why a quantity less than 50,000 (i.e., your answer from part a) is actually the efficient quantity. M 9 W 4:36 PM 10/17/2020