Asked • 01/06/20

Positive Externalities, Public Goods, Pigouvian Taxes and Subsidies, Game Theory and the NBA part 4

This is the fourth part of a really neat exercise which covers elements of Imperfect markets (Duopsony), game theory, public economics, positive external benefits Pigouvian taxes and subsidies and elements of General Equilibrium and Cournot-Nash solutions. We will also have the opportunity to play with logarithms and Taylor expansions (yippee!!).

Suppose we have two players, Curry and Durand.  They like to play one-on-one games for the young people of San Francisco to help promote the sport.  To do this they must rent seats from a local arena They have preferences which could be characterized by the two utility functions:

D = ln(Xd-3)+ln(S-6)

and

C=ln(Xc-3)+ln(S-6)

 The total number of seats is equal to the sum of the number of seats that each one of them buys.

Formally,

S= Sc+Sd.

Their incomes are given as Yc =36 and Yd = 24 the price of both seats, S and other stuff, X is equal to 1 so they can allocate their incomes across seats and other stuff according to their budget constraints which are given formally as, Yd= 24= Sd+Xd and Yc=36=Xc +Sc.

Note that looking at the utility functions if either one of these players increases their purchases of seats, the audience will be larger and they will both be happier. What we have here is joint consumption. We have a positive external benefit.

We have already determined the MRS for both players = MRSCurry=(S-6)/(Xc-3) and MRSDurand=(S-6)/(Xd-3). Remember that Seats are “consumed” jointly while other stuff, (Xc and Xc) are consumed exclusively). The Reaction or “Best Response” Functions were determined to be

Sc= (39/2) – (1/2)Sd.    (1)

This is Curry’s Reaction or Best Response function to the number of seats Durand purchases.


Doing the same for Durand we see

Sd= 27/2 – ½(Sc)       (2)

We Know the Cournot Nash Solution has Sc=17, Sd=5 and Xc=Xd=19

.

a)      What would happen to the utility of each player if they both agreed to purchase one more seat and one less unit of x? 

b)     Determine the social marginal rate of substitution.

c)      Define the social planner’s problem and calculate the solution for the optimal quantity of S. How much s would each player purchase question how much would each player consume a good X?

1 Expert Answer

By:

Lenny D. answered • 01/06/20

Former Tufts Economics Professor and Wall Street Economist

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