Mary, Kiki, and Roy are the only three people in Tinville. Mary is willing to pay $20 for the 5th unit of a public good, Kiki $15, and Roy $25. Government should produce the 5th unit of the public good if the marginal cost is:
a. between $15 and $25.
b. between $61 and $299.
c. $300 or more.
d. $60 or less.
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The first thing that you have to remember when answering this question is that the consumption of public goods is nonrivalrous. That means that one person’s consumption of a public good does not reduce someone else’s consumption of that good. This is important for this question because it means that all three of these people can consume the good. Therefore, we have to look at the total benefit that the three of them would get from the production of the fifth unit of the public good.
If the good in this question were a private good, only one person would be able to consume the fifth unit that is produced. Because it is a public good, all of them will be able to. That means we have to add the prices that they would each be willing to pay to find out how much the fifth unit is worth to them as a group. The sum of the prices they would pay is $60 ($25 + $20 + $15). This means that the marginal benefit of producing the fifth unit is $60.
Efficiency in the production of public goods is achieved when the marginal cost is less than or equal to the marginal benefit of the last unit produced. Therefore, it will be efficient for the government to produce the fifth unit so long as the price is not higher than $60. In that case, D is the correct answer.
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