Question

A city is considering how much to spend to hire people to monitor its parking meters. The following information is available to the city manager:

• Hiring each meter-monitor costs \(10,000 per year.

• With one monitoring person hired, the probability of a driver getting a ticket each time he or she parks illegally is equal to .25.

• With two monitors, the probability of getting a ticket is .5; with three monitors, the probability is .75; and with four, it's equal to 1.

• With two monitors hired, the current fine for overtime parking is \)20.

1. Assume first that all drivers are risk-neutral. What parking fine would you levy, and how many meter monitors would you hire (1, 2, 3, or 4) to achieve the current level of deterrence against illegal parking at the minimum cost?

2. Now assume that drivers are highly risk-averse. How would your answer to (a) change?

3. (For discussion) What if drivers could insure themselves against the risk of parking fines? Would it make good public policy to permit such insurance?

Short answer

1. The fine should be $40, and one monitor should be hired.

2. To maintain the current level of deterrence, the fine levied should be lower than $40.

3. With the insurance, the drivers will get many more parking tickets. No, it will not make a good public policy.

Step-by-step solution

Explanation for part (a)

The driver's behavior changes as the drivers are neutral to risks. The expected fine will be $10 when 2 monitors are hired; the probability of detection is 0.5 with a fine of $20; the expected fine will be $0.5\times \$20=\$10$. Hence, to maintain the fine as $10, with one monitor, the fine will increase to $40 (role="math" localid="1653919701474" $=\$10÷0.25$); with three monitors, the fine will increase to $13.33 (role="math" localid="1653919707309" $=\$10÷0.75$); with four monitors, the fine will increase to $10 (role="math" localid="1653919713235" $=\$10÷1$).

The city will hire one monitor and increase the fine to $40.

Explanation for part (b)

When the drivers are risk averse, they avoid paying the fines in comparison to those who are risk neutral. Hence, to maintain the current level of deterrence, the fine should be less than $40.

Explanation for part (c)

When the drivers are insured, they will not worry when they get tickets as the insurance company will pay on their behalf. With the insurance, the drivers will not worry about the parking place because there is no personal cost; thus, they will receive more and more parking tickets.

This would not make a good public policy as the parking fee is levied on the use of scarce space. When the drivers have insurance for the parking fee, then will be no incentive to get a metered parking space or to take public transportation instead. Thus, this will lead to a shortage of parking space, and some drivers will not get to park; thus, there will be inefficiency in allocating of parking space. Hence, it will not be a good public policy to permit insurance.