Question

Suppose that Company A's railroad cars pass through Farmer B's corn fields. The railroad causes an externality to the farmer because the railroad cars emit sparks that cause $1,500 in damage to the farmer's crops. There is a special soy-based grease that the railroad could purchase that would eliminate the damaging sparks. The grease costs $1,200. Suppose that the railroad is not liable for any damage caused to the crops. Assume that there are no transaction costs. Which of the following characterizes the efficient outcome?

In which of the following situations will the total revenue increase?

a) Price elasticity of demand is 1.2 and the price of the good decreases.

b) Price elasticity of demand is 0.5 and the price of the good decreases.

c) Price elasticity of demand is 3.0 and the price of the good increases.

d) All of the above.

Answer 1

a) Price elasticity of demand is 1.2 and the price of the good decreases.

Explanation: In the case of elastic demand, total revenue increases when price decreases. In the case of inelastic demand, total revenue increases with an increase in price.