solve this problem (law of economic)

qenoohat
timer Asked: Apr 21st, 2015

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econ6.docx

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1. Roofers sometimes fall off roofs. Assume that there are no precautions the homeowner can take to lower the probability that such an accident occurs when a new roof is being put on. Assume that when the roofers take the optimal level of precaution, the probability of an accident is 0.02 and the average cost of falling off a roof in lost wages and medical care is $20,000. The demand and supply curves for roof repair, not including any accident or legal costs, are given below. Demand Supply Price Quantity Price Quantity $2000 $1800 $1600 $1400 $1200 $1000 $800 $600 100 200 300 400 500 600 700 800 $400 $500 $600 $700 $800 $900 $1000 $1100 100 200 300 400 500 600 700 800 a. Suppose that there is no liability for roofing related accidents, that is, roofers must bear the costs of their accidents. They are fully aware of the relevant probabilities, and can purchase insurance at actuarially fair rates if they wish. What will be the probability of an accident, and what will be the equilibrium price and quantity of roofing services? b. Suppose that homeowners are given strict liability for roofing related accidents. Assume that homeowners can insure against this liability at actuarially fair rates, and that homeowners or their insurance companies can assess the level of precaution typically taken by a roofer. What will be the probability of an accident, and what will be the equilibrium price and quantity of roofing services? c. You should reach the same quantity result in both part a. and part b. Draw and label a diagram to show that you understand why this happens. d. Suppose that homeowners are given strict liability for roofing related accidents, but now assume that homeowners generally underestimate the probability that a roofer will have an accident. Because of this, insurance companies cannot make money selling policies to insure homeowners for the losses they might suffer due to roofing accidents. Also, homeowners have little way of knowing which roofing companies operate more safely. (i) Compared to the equilibrium in part b, will the price of having a new roof put on be higher or lower? Explain. (ii) Compared to the equilibrium in part b, will there be more or fewer roofing-related accidents? Why? e. Propose and defend a negligence or liability rule for this market, and justify it in terms of your own assumptions about who has what information, who can take precautions, and how insurance markets are likely to deal with this sort of risk in the real world. 2. Economists recommend that crime policy have the goal of minimizing the “costs of crime”, which include the social costs of the crimes themselves and the social cost of enforcing the criminal law. a. What is the general rule for determining whether a particular change in criminal justice policy will increase or decrease social efficiency? b. It has been proposed from time to time that Michigan release some current prisoners to probationary status in order to save money. Consider a program that would allow prisoners sentenced to more than two years for nonviolent offenses to be released, provided that they had served 85% of their term. The released prisoners would still be on probation until the end of their sentences. It was estimated that about 7500 current Michigan prisoners would be eligible for the program. What are three pieces of quantitative information you would want to have (or have a good estimate of) in order to evaluate this proposal from the point of view of social efficiency, and why? 3. In some states, the criminal who commits a particular crime with a gun will receive a much longer sentence than the criminal who commits the exact same crime (for example, a mugging, a convenience store robbery, or a car theft) using some other weapon like a knife or a baseball bat. These laws obviously increase the cost of preventing crime, because longer sentences for criminals are more costly to society. Offer one reason why increasing the punishment associated with the same crime committed in a different way would lower the social cost of crime.
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