1.) John and Judy are the only two residents in a neighborhood, and they would l
ID: 1203568 • Letter: 1
Question
1.) John and Judy are the only two residents in a neighborhood, and they would like to hire a security guard. The value of a security guard is $60 per month to John and $180 per month to Judy. Irrespective of who pays the guard, the guard will protect the entire neighborhood.
a. What is the most a guard can charge per month and still be assured of being hired by at least one of them? Who would that be?
b. Suppose the competitive wage for a security guard is $140 per month. The local government proposes a plan whereby John and Judy each pay 50 percent of this monthly fee, and asks them to vote on this plan. Will the plan be voted in? Would economic surplus be higher if the neighborhood had a guard? Briefly explain.
Explanation / Answer
a.
The guard can charge the most $180 per month, since this is the highest value amongst the lot.
The guard will be hired by Ju atleast, because the value of a guard to other neighbor is much lower and he will not pay such high rate.
b.
Jo’s willingness-to-pay = $60
Ju’s willingness-to-pay = $180
Jo pay = $140 × 50% = $70
Ju pay = $140 × 50% = $70
The plan would not be voted in, since Jo would not vote because of his higher payment what he is willing to pay. Actually, he has to pay more by (70 – 60 =) $10.
Economic loss = (Jo pay - Jo’s willingness-to-pay) + Difference in total price
= (70 – 60) + (180 – 140)
= $50
Economic surplus = Ju’s willingness-to-pay - Ju pay = 180 – 70 = $110
Economic surplus would be higher if there is a guard.
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