econ chp 8

Investing more capital and labor to reduce pollution is efficient in such a situation.

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Governments provide an alternative method to markets for supplying goods and services when it appears that the benefits to society of doing so outweigh the costs to society. Not all individuals will bear the same costs or share the same benefits of those policies.

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Public goods provide benefits to more than one person at a time, and their use cannot be restricted to only those people who have paid to use them.

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increased concerns about pollution have probably caused the marginal social benefit curve to shift to the right over time, increasing the optimal amount of pollution control. Because of measurement problems, however, it is difficult to state whether we are generally below, at, or above the optimal pollution level.

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What is the advantage to the pollution rights approach?

-creates an incentive for polluters to develop improved pollution abatement technologies -The prospect of buying and selling pollution permits would allow firms to move into an area that is already as polluted as allowed by EPA standards.

resources of misallocation

-externalities -public good

possible solutions to the common property rights problem

-government, through taxes and fees, can attempt to internalize the externality. To prevent road congestion, the government could charge drivers a toll—a corrective tax on congestion—or it could charge higher tolls on bridges during rush hour. -Second, the government could assign private property rights to common resources. For example, private fish farms have become more profitable as overfishing depletes the stock of fish in open waters.

What Can the Government Do to Correct for Negative Externalities?

-pollution taxes (internalize negative externalities ) -regulation pollution tax, or a corrective tax, is more efficient than regulation.

What Can the Government Do to Correct for Positive Externalities?

-subsidies (either give refunds to individuals who receive an inoculation or provide an incentive for businesses to give their employees "free" inoculations at the office) -regulation (The government could also pass a regulation requiring each person to get an inoculation)

adverse selection versus moral hazard

Adverse selection is the phenomenon that occurs when one party in the exchange takes advantage of knowing more than the other party. Moral hazard involves the action taken after the exchange, such as if you were a nonsmoker who had just bought a life insurance policy and then started smoking heavily.

Why are externalities also called spillover effects?

An externality exists whenever the benefits or costs of an activity impact individuals outside the market mechanism. That is, some of the effects spill over to those who have not voluntarily agreed to bear them or compensate others for them, unlike the voluntary exchange of the market.

What are the objectives of an ideal pollution control policy from the perspective of economists interested in resource allocation?

An ideal pollution control strategy from the perspective of economists interested in resource allocation would reduce pollution to the efficient level, it would do so at the lowest possible opportunity cost, and it would create incentives to motivate advances in pollution abatement technology.

How do command and control policies act to internalize external costs?

By forcing companies to find less pollution-intensive ways of production rather than imposing the costs of additional pollution on others, they are forced to internalize those costs formerly imposed on others.

What is the tragedy of the commons?

Common resource goods often lead to overuse because if no one owns the resource, they are not likely to consider the cost of their use of the resource on others. This is the so-called tragedy of the commons. This problem has led to overfishing. Of course, you could remove the common and make the resource private property, but assigning private property rights to a vast ocean area would be virtually impossible.

How do external benefits affect the output of an activity that causes them?

External benefits are benefits that spill over to others because the party responsible need not be paid for those benefits. Therefore, some of the benefits of an activity to society will be ignored by the relevant decision makers in this case, and the result will be a smaller output and a higher price for goods that generate external benefits to others.

How can the government intervene to force producers to internalize external costs?

If the government could impose a tax or fee on producers equal to the external costs imposed on people without their consent, producers would have to take those costs into account. The result would be that those costs would no longer be external costs, but internalized by producers.

How do external costs affect the price and output of a polluting activity?

If the owner of a firm that pollutes does not have to bear the external costs of pollution, she can ignore those real costs of pollution to society. The result is that the private costs she must pay are less than the true social costs of production, so that the market output of the polluting activity is greater, and the resulting market price less, than it would be if producers did have to bear the external costs of production.

Why can externalities be considered a property rights problem?

If the rights to clean air, water, and so on, were clearly owned, those that infringe on those rights would be forced to compensate the owners. Such costs would be internalized, rather than external, to the relevant decision makers. Therefore, externalities are the result of the absence of clear and enforceable property rights in certain goods.

What is the tragedy of the commons?

In early America, New Englanders had privately owned gardens to grow their own food, but they also had established commons for grazing livestock. Settlers had an incentive to protect their own private lands but not the publicly owned commons. As a result, the commons were soon overgrazed and no longer able to support the villagers' cattle, creating the so-called Tragedy of the Commons. social science to describe a situation in a shared-resource system where individual users acting independently according to their own self-interest behave contrary to the common good of all users by depleting or spoiling that resource through their collective action.

How is the optimal amount of pollution control determined, in principle?

In principle, the optimal amount of pollution control is the amount at which the marginal social benefit of pollution reduction equals the marginal cost of pollution reduction. But there is no clear agreement about what those marginal benefits or costs are, leading to disagreements about the optimal amount of pollution.

How do substantial warranties offered by sellers of used cars act to help protect buyers from the problem of asymmetric information and adverse selection? Why might too extensive a warranty lead to a moral hazard problem?

In the used-car market, the seller has superior information about the car's condition, placing the buyer at an information disadvantage. It also increases the chance that the car being sold is a "lemon." A substantial warranty can provide the buyer with valuable additional information about the condition of the car, reducing both asymmetric information and adverse selection problems.

If a positive externality results from the consumption of higher education, then the marginal benefit students receive from education:

Is less than the marginal social benefit

_________ arises from the cost involved for the insurer to monitor the behaviors of the insured party.

Moral hazard

How are public goods different from private goods?

Private goods are rival in consumption and exclusive Public goods are nonrival in consumption and nonexclusive

Which of the following will most likely generate positive externalities of consumption?

Public education

What is the relationship between externalities and property rights?

The existence of externalities and the efforts to deal with them in a manner that will enhance the social good can be considered a question of the nature of property rights. Sometimes, to deal with externalities, governments radically alter arrangements of property rights. externalities involve an evaluation of the legal arrangements under which we operate our economy and thus illustrate one area where law and economics merge.

Why do most cities have more stringent noise laws for the early morning and late evening hours than for during the day?

The external costs to others from loud noises in residential areas early in the morning and late in the evening are higher because most residents are home and trying to sleep, than when many people are gone at work or are already awake in the daytime. Given those higher potential external costs, most cities impose more restrictive noise laws for nighttime hours to reduce them.

Why does the free-rider problem arise in the case of public goods?

The free-rider problem arises in the case of public goods because people cannot be prevented from enjoying the benefits of public goods once they are provided. Therefore, people have an incentive not to voluntarily pay for those benefits, making it difficult or even impossible to finance the efficient quantity of public goods through voluntary market arrangements.

In what way can government provision of public goods solve the free-rider problem?

The government can overcome the free-rider problem by forcing people to pay for the provision of a public good through taxes.

How does pollution control lead to both rising marginal costs and falling marginal benefits?

The marginal costs of pollution control rise for the same reason it is true of other goods. Pollution will be reduced in the lowest cost manner first. Once lower cost pollution control methods are exhausted, if we wish to reduce pollution further, we will have to turn to progressively more costly methods. The marginal benefits from pollution controls will fall because the value of reducing crud in the atmosphere is higher the more crud there is. As controls reduce the level of crud in the air, the marginal benefit of further crud reductions will fall.

Which of the following is not an advantage of transferable pollution rights?

They require polluters to reduce emissions, regardless of the cost.

_______, the costs of negotiating and executing exchanges, must be low for well-defined property rights to allow externalities to be internalized.

Transaction costs

How do transaction costs limit the market's ability to efficiently solve externality problems?

Transaction costs limit the ability of the market mechanism to internalize externalities because trading becomes more difficult. The free-rider problem—where those who benefit from some action cannot be forced to pay for it—also hinders the ability for voluntary trade across markets to generate efficient levels of goods such as cleaner air.

How could transferable pollution rights lead to pollution being reduced at the lowest possible opportunity cost?

Transferable pollution rights would create a market for pollution reduction. Every polluter would then find it profitable to reduce pollution as long as they could do it more cheaply than the price of a pollution right. Therefore, producers would employ the lowest-cost pollution control methods for a given amount of pollution reduction.

many economists would like to see greater effort made to force internalization of externalities through taxes rather than using alternative approaches. Why?

We know that firms will seek out the least-expensive (in terms of using society's scarce resources) approaches to cleanup because they want more profits.

Why, according to the Coase theorem, will externalities tend to be internalized when property rights are clearly defined and information and transaction costs are low?

When property rights are clearly defined and information and transaction costs are low, whoever wants to exercise their right faces an opportunity cost of what others would pay for that right. That opportunity cost, represented by the potential payment from others to sell the right, is what forces decision makers to internalize what would otherwise be an externality.

Refer to Exhibit 8-2. Market equilibrium and efficient equilibrium are denoted by points _____ respectively.

a and b

regulation

a firm has little incentive to further reduce emissions once it reaches the predetermined level set by the regulated standard.

private good

a good with rivalrous consumption and excludability like food, clothing, cars, and houses, are private goods that are rival and excludable.

What are transferable pollution rights?

a right given to a firm to discharge a specified amount of pollution; its transferable nature creates incentive to lower pollution levels

What is a common resource good?

a rival good that is nonexcludable nonpayers cannot be easily excluded from consuming the good, and when one unit is consumed by one person, it means that it cannot be consumed by another. (Fish in the sea)(congested road and the internet)

adverse selection

a situation where an informed party benefits in an exchange by taking advantage of knowing more than the other party

When one party enters into an exchange with another party that has more information, we call it ______- selection.

adverse

Nonpecuniary costs

are real costs and potentially have a monetary value that can be associated with them, but assessing that value in practical terms is immensely difficult.

The existence of _______may give rise to signaling behavior.

asymmetric information

When the available information is initially distributed in favor of one party relative to another, __________ is said to exist.

asymmetric information

why isn't a public good a rival

because everyone can consume the good simultaneously

why does The government frequently subsidizes education?

because the private market does not provide enough. It is argued that the education of a person benefits not only that person but all society because a more informed citizenry can make more intelligent collective decisions, which benefits everyone.

Under a system of transferable pollution rights, firms with high costs of abatement would likely be -_____, and firms with low costs of abatement would be ______

buyers; sellers.

Transferable pollution rights ______ work when the EPA does not know the cheapest way for polluters to reduce their emissions because they make it in polluters' interests to reduce pollution the cheapest way.

can

The Coase theorem suggests that private solutions to externality problems

can lead to an optimal allocation of resources if private parties can bargain at relatively low cost.

Fish in the vast ocean are a good example of a(n________ resource.

common

Goods that are owned by everyone and therefore not owned by anyone are called ________resources.

common

If firms were required to pay the full social costs of the production of goods, including both private and external costs, other things being equal, there would probably be a(n)

decrease in production.

What is the free-rider problem?

derive benefits from something they did not pay for The rub is that if everyone attempts to take a free ride, the ride will not exist. The free-rider problem prevents the private market from supplying the efficient amounts of public goods. That is, no private firm would be willing to supply national defense because people can consume it without paying for it—the free-rider problem. Therefore, the government provides important public goods such as national defense.

In the case of a private solution to the externality problem, the distribution of rights

determines who bears the cost of the solution but does not affect the efficient result.

Pollution reduction, like other forms of production, is subject to _______ returns.

diminishing

Public goods

do not need to be produced by government. are subject to free-rider problems. tend to be underproduced in the marketplace.

Taxes on the emissions of polluting firms are primarily intended to

encourage firms to pollute less.

The economically ideal tax to impose on a polluter would be ______the marginal external costs imposed on others by its production.

equal to

According to the Coase theorem, one way to deal with an externality problem when transaction costs are low is

for the government to make certain that property rights are well defined.

An ideal pollution tax

forces a firm to internalize the externality.

When individuals derive the benefits of a good without paying for it, it is called a(n)

free ride.

Compliance standards should be stricter where the marginal benefit from pollution reduction is

greater.

Eliminating nearly all pollution would be economically _______because the marginal _______ would exceed the marginal _______

inefficient ; costs; benefits

If the government taxed a manufacturer by the amount of those external costs it imposes on others, it would force the manufacturer to _________ the costs.

internalize (bear)

A common resource

is rivalrous in consumption. is nonexcludable. can lead to the tragedy of the commons.

When large numbers of individuals are affected by an external cost, the transaction costs of using voluntary negotiation to internalize it is likely to be _______

large.

The imposition of per-unit pollution taxes would likely be______ costly than compliance standards for the same degree of pollution abatement.

less

If a firm can avoid paying the external costs it imposes on others, it _____ its own costs of production but not the ____ cost to society.

lowers;true

Compared to compliance standards, pollution taxes lead to abatement by firms who can do so at the _______cost.

lowest

An advantage that emission taxes and tradable emissions permits have over compliance standards is that the former

make it in the interests of firms to reduce pollution in the most efficient manner possible.

The optimal quantity of pollution is where the _______ of pollution abatement equals the _______ from pollution abatement.

marginal benefit; marginal cost

Why does the government provide public goods?

market has not provided them

If once a good is produced it is prohibitively costly to exclude anyone from consuming the good, consumption of that good is called

nonexcludable.

Unlike the consumption of private goods, the consumption of public goods is both_____ and_______

nonexcludable; nonrivalous.

If everyone can consume a good simultaneously, it is

nonrivalous.

A public good is both____ in consumption and ._______

nonrivalrous; nonexclusive

asymmetric information

occurs when the available information is initially distributed in favor of one party relative to another in an exchange

why ins't a public good excludable

once the good is produced, it is prohibitively costly to exclude anyone from consuming the good (National Defense)

If suppliers are unaware of or not responsible for the external costs created by their production, the result is a(n) ________of scarce resources to the production of the good.

overallocation

What is the "best" level of pollution?

point where the marginal benefit equals the marginal cost of pollution.

The benefits of a product or service that spill over to an outside party not involved in producing or consuming the good are called ________

positive externalities.

The market system fails to provide the efficient output of public goods because

private firms cannot restrict the benefits from those goods to consumers who are willing to pay for them.

Problems of external costs are largely a question of how _______ should be assigned.

property rights

According to the Coase theorem, markets can internalize externalities as long as ________ are well-defined and _______ costs are low.

property rights; transaction

A tax equal to the external cost on firms that emit pollutants would

provide firms with the incentive to decrease the level of activity creating the pollution.

The government may be able to overcome the freerider problem by ______ the public good and imposing taxes to pay for it.

providing

The marginal cost of pollution abatement _____ with increasing levels of abatement.

rises

What is a common resource?

rival in consumption but nonexcludable.

A college education can provide a(n) _______about a person's intelligence and perseverance.

signal

Good warranties are an example of _________behavior that takes place because the ______ may know the actual quality of durable goods better than the______-

signaling ;sellers; buyers.

The presence of negative externalities leads to a misallocation of societal resources because

some costs are associated with production that the producer fails to take into consideration.

What is the Coase theorem?

states that where property rights are defined in a clear-cut fashion, externalities are internalized when the benefits are greater than the costs for some course of action (say, environmental cleanup), potential transactions can make some people better off without making anyone worse off

In the case of externalities, appropriate government corrective policy would be

subsidies in the case of external benefits and taxes in the case of external costs.

What is moral hazard?

taking additional risks because you are insured arises from the fact that it is costly for the insurer to monitor the behaviors of the insured party.

Pollution reduction will be achieved for the least cost when

the cost of reducing pollution by an additional unit is the same for all polluting firms.

transaction cost

the costs of negotiating and executing an exchange, excluding the cost of the good or service bought.

tradeable permits policy,

the firm can set up operation by purchasing pollution permits from an existing polluter in the area. This type of exchange allows the greatest value to be generated with a given amount of pollution. It also encourages polluters to come up with cheaper ways of reducing pollution because the firm that reduces pollution is able to sell its pollution credits to others, making pollution reduction profitable.

under allocation

the inability of a market to bring about the allocation of resources that best satisfies the wants of society;

If compliance standards are too stringent,

the marginal social cost of pollution reduction may outweigh the marginal social benefit of pollution reduction.

If, after you buy a car with air bags, you start to drive recklessly, it would be an illustration of

the moral hazard problem.

Adverse selection refers to

the phenomenon that occurs when one party in an exchange takes advantage of knowing more than another party.

the presence of positive externalities interferes with reaching economic efficiency because why?

the tendency for the market to underallocate (produce too little) of this good.

In the case of a good whose production generates negative externalities,

those not directly involved in the market transactions are harmed.

In the market for insurance, the moral hazard problem leads

those who buy insurance to take fewer precautions to avoid the insured risk.

What are command and control regulations?

to require private enterprise to produce their outputs in a manner that would reduce negative externalities below the amounts that would persist in the absence of regulation.

Assume that production of a good imposes external costs on others. The market equilibrium price will be _____and the equilibrium quantity _______ for efficient resource allocation.

too low; too high

Assume that production of a good generates external benefits of consumption. The market equilibrium price of the good will be _________and the equilibrium quantity_______ for efficient resource allocation.

too low; too low

The failure of private incentives to provide adequate maintenance of public resources is known to economists as the

tragedy of the commons.

Firms buy and sell rights to pollute under a system of ________ rights.

transferable pollution

In the case of either external benefits or external costs, buyers and sellers are receiving the wrong signals: The apparent benefits or costs of some actions differ from the _______ benefits or costs.

true social

Because producers are unable to collect payments from all who are benefiting from the good or service, the market has a tendency to _______ goods with external benefits.

underproduce

If there are significant external benefits associated with the consumption of a product, it can be said that the private benefit to the consumer _____ the relative importance of this product to society and output should _____ to the move toward the efficient situation.

understates; increase

pollution taxes

unlike other taxes, can enhance economic efficiency while generating revenue for the government.