Unit 9 Assignment: Externalities

Education is an example of a positive externality: acquiring more education benefits the individual student and having a more highly educated work force is good for the economy as a whole.
The accompanying table illustrates the marginal benefit to Sian per year of education and the marginal cost per year of education. Each year of education has a marginal external benefit to society equal to $8,000. Assume that the marginal social cost is the same as the marginal cost paid by an individual student.
Quantity of Education
(in years)
Sian’s Marginal Benefit
per year
Sian’s Marginal Cost
per year
9
–
–
10
$20,000
$15,000
11
19,000
16,000
12
18,000
17,000
13
17,000
18,000
14
16,000
19,000
15
15,000
20,000
16
14,000
21,000
17
13,000
22,000
Find Sian’s market equilibrium number of years of education
Calculate the marginal social benefit schedule
Years of Education
Sian’s marginal benefit per year
Marginal external benefit to society
Marginal social benefit
Sian’s marginal cost per year
9
–
–
–
–
10
$20,000
$8,000

$15,000
11
19,000
8,000

16,000
12
18,000
8,000

17,000
13
17,000
8,000

18,000
14
16,000
8,000

19,000
15
15,000
8,000

20,000
16
14,000
8,000

21,000
17
13,000
8,000

22,000
What is the socially optimal number of years of education?
You are in charge of education funding. Would you use a Pigouvian tax or a Pigouvian subsidy to induce Sian to choose the socially optimal amount of education? Justify your answer.
How high would you set this tax or subsidy per year of education? Justify your answer.
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