Author Question: Suppose a chemical plant regularly dumps chemicals into a river that must be cleaned up before ... (Read 131 times)

yoroshambo · **on:** Jun 29, 2018

Suppose a chemical plant regularly dumps chemicals into a river that must be cleaned up before farmers located downstream can use the water on their crops.

Dumping the chemicals into the river saves the chemical plant 750,000 in yearly disposal costs and cleaning the water costs farmers 825,000 each year. Explain what the benevolent social planner would like to see happen in this case.

Question 2

Discuss why a budget deficit results in a different real interest rate under the Ricardo-Barro effect than under the crowding-out effect.

What will be an ideal response?

gabrielle_lawrence · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

Since the cost to clean the water is greater than the cost of disposing the chemicals in a way other than dumping them into the river, the benevolent social planner would like to see the chemical plant not dump the chemicals in the river.

Answer to Question 2

The Ricardo-Barro effect holds that a budget deficit has no effect on real interest rates. A government budget deficit increases the demand for loanable funds. The Ricardo-Barro effect argues that rational taxpayers know that a budget deficit today means higher taxes tomorrow. As a result, taxpayers increase their savings today. The higher private saving increases the supply of loanable funds. Because both the demand for loanable funds and the supply of loanable funds increase by the same amount, there is no change in the real interest rate.
The crowding-out effect holds that a budget deficit increases real interest rates. The crowding-out effect argues that a budget deficit has no effect on the supply of loanable funds. Hence only the demand for loanable funds increases so that the real interest rate rises.