HW18_Sketch_Solutions

ECO 206Y1Y: Microeconomic Theory Prof. Freitas, University of Toronto Eco 206 HWX Sketch Solutions These are sketch solutions only. If you still have questions, please stop by office hours. Q1 This is the example from class that we didn’t get a chance to finish. We have two firms whose cost of reducing pollution by q units is c A ( q A ) = q 2 A and c B ( q B ) = 2 q 2 B . The Marginal external cost of pollution is = 10 . What tax on pollution will get the optimal pollution reduction? Explain your reasoning. Solution: The first part you know from workshop. The optimal pollution reduction is determined by choosing max q A ,q B 10 ( q A + q B ) - q 2 A - 2 q 2 B FOC 10 = 2 q A ⇒ q A = 5 10 = 4 q B ⇒ q B = 2 . 5 However each firm is only considering their own private costs and benefits. The cost is clear from the cost functions. What is the benefit of reducing pollution? In the same way we got the benefit from the social perspective, it is what you save by reducing pollution. Here firms save the per-unit pollution tax they would pay if they didn’t reduce pollution. The firm solves max q A τ ( q A ) - q 2 A FOC τ = 2 q A max q B τ ( q A ) - 2 q 2 B FOC τ = 4 q B To get the optimal pollution reduction, notice that the firm should face a τ = 10 which also happens to be the marginal external cost of pollution. While the setup looks different, notice that the general insight remains the same–the tax that implements the efficient quantity is equal to the MEC at the efficient outcome. Q2 Consider a firm looking to hire a worker. They firm want to hire the most productive workers. 1) Focusing on the hiring process, what type(s) of information asymmetry do we have and why do they matter for the firm and for the worker? 2) During the hiring process, a manager decides to do a deep dive into every candidate’s social media. They claim this will help reduce information asymmetry and help them hire better candidates for the job. Do you agree? Explain your reasoning. 3) The firm is worried about is that high productivity workers don’t want to apply because the wage they offer is too low. Another manager suggests offering very high wages. The good workers they hire will make this a profitable strategy. Do you agree? Explain your reasoning. Solution: 1) Here you always want to focus on what is hidden–a characteristic or an action. If the firm is worried about worker productivity, it is most likely hidden characteristics or hidden skills. Once you hire the worker, you can worry about getting them to put in the required effort (hidden action), for now it is about finding the right match. It matters for the firm, because the more productive worker the higher the benefit to the firm. The high skill worker cares because they want to be compensated for their skills. The low skill worker wants to get the higher wage. 202209 1 of 2 HWX