have made enormous 'profit' by selling the licence.
Concepts development
The teacher introduces the concept of economic rent.
The teacher asks students to explain Ah Kwai's decision in terms of opportunity cost.
The teacher explains to students that Ah Kwai's possible gain is economic rent which is a cost, not profit.
Suggested Teaching Time 2-3 periods
Further Development
With additional information from the newspaper, and modification of the hypothetical case, teachers can further pursue the case to teach expected gain and windfall profits.
Part A
Ah Kwai successfully bought a taxi licence in 1982 at a price of $200 000. He operated the taxi himself and derived stable income. He expected the price of taxi licence to go up in succeeding years.
Part B
But contrary to his expectation, the price of taxi licence dropped in 1983 and 1984.
Part C
Ah Kwai continued to hold the taxi licence. In Dec. 1991 his friends persuaded him to sell his licence at a price of $1 550 000 convincing him that he would gain a profit of HK$1,350,000.
Average price of an urban taxi licence in government tenders
Date
No. of Licences Issued
Average
tender price ($) % of change
Feb 82 300 178,646 +4.0
June 300 183,023 +2.5
Sept 300 206,550 +12.9
Dec 300 182,674 -11.6
May 83 301 160,758 -12.0
July 301 143,864 -10.5
Oct 300 133,901 -6.9
Jan 84 300 140,221 +4.7
Apr 300 157,182 +12.1
July 300 164,886 +4.9
Jan 85 100 199,255 +20.8
June 100 219,771 +10.3
Jan 86 100 292,026 +32.9
June 100 372,042 +27.4
Jan 87 100 449,640 +20.8
July 100 597,122 +32.8
Feb 88 168 600,886 +0.6
July 100 694,443 +15.6
Sept 89 200 820,545 +18.2
Dec 90 150 909,562 +10.8
Dec 91 200 1,510,000 +66.0
(From newspaper cutting)
Topic: The problem of social cost
A Case study: A case of externality - Lead in Petrol
Objectives
At the end of the lessons, students should be able to:
(1) define external cost.
(2) identify the private costs, external costs and social costs of an action.
(3) explain how the divergence between private and social costs leads to inefficient allocation.
(4) suggest some traditional measures for correcting externalities.
(5) make comments on these measures.
Suggested Teaching Approach Introduction:
The teacher introduces the concept of external cost to the students.
Class discussion:
The teacher asks students to bring news cuttings about externalities to the lesson. Then they are required to explain why they think externalities exist in each case.
Class study:
To arouse attention, students are given a cartoon picture RM 2.1 showing the external effect of lead in petrol.
With additional information, RM 2.2, let students discuss the questions that follow.
Conclusion:
In conclusion, explain to students that it is costly and also usually inefficient to reduce externalities by government intervention, though these measures are still in practice.
Suggested Teaching Time 3-4 periods
Further Development
Based on the comments on the traditional treatment of externalities, introduce Coase's view on this issue.
LEAD IN PETROL
Lead is added to petrol with an aim of increasing the performance of car engines. Lead, however, goes into the atmosphere through vehicle emissions. It is believed that 95% of the lead content in air is resulted from car exhausts.
Lead affects cell and body processes. It can affect the brain, heart and kidneys. Studies show that lead does more harm to young children, with likely neuro-psychological effects.
In order to safeguard the health and well-being of the community, some governments have asked the petrol companies to produce unleaded petrol (ULP). The companies, however, were not in favour of this since it would involve them an enormous amount of money.
1. What are the external costs of using lead in petrol?
Why do you think these are external costs?
2. Why don't petrol companies consider the external costs of their decision to produce petrol with lead added to it?
3. What are the means a government can use to encourage petrol companies to reduce the production of petrol with lead? Explain your answer.
4. What does the Hong Kong government do to discourage the consumption of petrol with lead?
5. What are the possible difficulties that the government will encounter in using the measures in (3) and (4)?
Topic : The problem of social cost
A problem solving : A numerical illustration of the Coase's Theorem - Cattle raising and wheat growing.
Objectives
At the end of the lessons, students should be able to :
(1) understand the implication of externality - potential gain from trade.
(2) find that the allocation of resources is the same under different assignments of rights, assuming zero transaction costs.
(3) find that different assignment of rights affect the wealth distribution only.
(4) understand that the Coase Theorem is actually a theorem of exchange.
(5) recognize the effect of transaction costs.
Suggested Teaching Approach Teaching concepts:
The teacher introduces Coase's view on externality:
---externality implies the existence of inefficiency.
---inefficiency implies the existence of potential gain from trade.
Revision of concepts:
The teacher recalls students' memory about theorem of exchange.
Problem solving exercises:
The teacher asks students to solve the problem. Remind them that people are wealth maximizers. (RM 3.1)
Concluding discussion:
The teacher uses the Coase Theorem as a conclusion, and discusses with students the two important conditions for the theorem to be valid. (RM 3.2)
Suggested Teaching Time 5 periods
A farmer grows wheat and a rancher raises cattle on adjacent plots of land. Assume no fence or natural boundary separates the two, and occasionally cattle stray into the planted fields and destroy part of the crops.
The following table shows that the rancher, in raising cattle, inflicts damage on crops:
herd size
marginal revenue
marginal private cost
marginal external cost (damage on crops)
($) ($) ($)
1 100 40 30
2 100 60 30
3 100 70 30
4 100 90 30
5 100 100 30
6 100 120 30
7 100 130 30
Questions:
1. If the rancher ignores the damage inflicted on the crops, what will be his herd size?
Is it an efficient allocation? Explain your answer.
2. Assume all transaction costs are zero. If the farmer has the exclusive right to use the land so that the rancher is liable for any damages caused by his herd. What action will the two parties take? What will be the herd size?
3. Again assume all transaction costs are zero. If the rancher is not liable for crop damage. That is, suppose the farmer has no legal recourse to seek compensation.
What action will the two parties take? What will be the herd size?
4. Under the different assignments of right described in (2) and (3), are the two herd sizes the same? Is the wealth distribution in (2) same as that in (3)?
5. If there is transaction cost for the two parties to get a compromise, do you think the allocation of resources will be the same as in (2) and (3)?