Chapter 10: Externalities

private cost

A producer's or supplier's cost of providing goods or services.

Negative externalities

Markets -produce a larger quantity than is socially desirable Government: tax

Positive externalities

Markets -produce a smaller quantity than is socially desirable Government: subsidy

Market-Based Policies

Provide incentives so that private decision makers will choose to solve the problem on their own: Corrective taxes Tradable Pollution Permits

Permit

Sets the Quantity

Corrective Taxes

Sets the price

Positive Externalities: Internalizing Externalities

Subsidies, Used as the primary method for attempting to internalize positive externalities.

total value

Total economic value (TEV) is a concept in cost-benefit analysis that refers to the value derived by people from a natural resource, a man-made heritage resource or an infrastructure system, compared to not having it

Command-and-Control Policies

Usually take the form of regulations: Forbid certain behaviors. Require certain behaviors

The difference between a corrective tax and a tradable pollution permit is that a) a corrective tax sets the price of pollution and a permit sets the quantity of pollution. b) a corrective tax creates a more efficient outcome than a permit. c) a corrective tax sets the quantity of pollution and a permit sets the price of pollution. d) a permit creates a more efficient outcome than a corrective tax.

a) a corrective tax sets the price of pollution and a permit sets the quantity of pollution.

Flu shots provide a positive externality. Suppose that the market for vaccinations is perfectly competitive. Without government intervention in the vaccination market, which of the following statements is correct? a. At the current output level, the marginal social benefit exceeds the marginal private benefit. b. The current output level is inefficiently low. c. A per-shot subsidy could turn an inefficient situation into an efficient one. d. All of the above are correct

a. At the current output level, the marginal social benefit exceeds the marginal private benefit. b. The current output level is inefficiently low. c. A per-shot subsidy could turn an inefficient situation into an efficient one.

A local manufacturing plant that emitted sulfur dioxide was forced to stop production because it did not comply with local clean air standards. This decision provides an example of.... a. a direct regulation of an externality. b.corrective taxes. c. a Coase theorem solution to an externality. d. the misuse of a subsidy.

a. a direct regulation of an externality.

When Lisa drives to work every morning, she drives on a congested highway. What Lisa does not realize is that when she enters the highway each morning she increases the travel time of all other drivers on the highway. In this case, the external cost of Lisa's highway trip a. increases the social cost above the private cost. b. lowers the social cost below the private cost. c. increases the social value above the private benefit. d. decreases the social value below the private benefit.

a. increases the social cost above the private cost.

Altering incentives so that people take account of the external effects of their actions a. is called internalizing the externality. b. can be done by imposing a corrective tax. c. is the role of government in markets with externalities. d. all of the above.

a. is called internalizing the externality. b. can be done by imposing a corrective tax. c. is the role of government in markets with externalities.

Tradable pollution permits

allow the voluntary transfer of the right to pollute from one firm to another.

Corrective taxes

are taxes enacted to correct the effects of a negative externality.

Transaction costs

are the costs that parties incur in the process of agreeing to and following through on a bargain

Most taxes distort incentives and move the allocation of resources away from the social optimum. Why do corrective taxes avoid the disadvantages of most other taxes? a. Corrective taxes apply only to goods that are bad for people's health, such as cigarettes and alcohol. b. Because corrective taxes correct for market externalities, they take into consideration the well-being of bystanders. c. Corrective taxes provide incentives for the conservation of natural resources. d. Corrective taxes do not affect deadweight loss

b. Because corrective taxes correct for market externalities, they take into consideration the well-being of bystanders.

Two firms, A and B, each currently dump 20 tons of chemicals into the local river. The government has decided to reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the river. The government gives each firm 10 pollution permits, which it can either use or sell to the other firm. It costs Firm A $100 for each ton of pollution that it eliminates before it reaches the river, and it costs Firm B $50 for each ton of pollution that it eliminates before it reaches the river. After the two firms buy or sell pollution permits from each other, we would expect that a.Firm A will no longer pollute, and Firm B will not reduce its pollution at all. b. Firm B will no longer pollute, and Firm A will not reduce its pollution at all. c.Firm A will dump 10 tons of pollution into the river, and Firm B will dump 10 tons of pollution into the river. d.Firm A will increase its pollution and Firm B will reduce its pollution.

b. Firm B will no longer pollute, and Firm A will not reduce its pollution at all.

When the production of a good results in a positive externality, the social value curve is a. below the demand curve, indicating that the total value to society is less than the private benefit. b. above the demand curve, indicating that the total value to society is greater than the private benefit. c. identical to the demand curve, indicating that the total cost to society is the equal to the private benefit. d. above the supply curve, indicating that the total cost to society exceeds the private cost.

b. above the demand curve, indicating that the total value to society is greater than the private benefit.

The difference between social cost and private cost is a measure of the a. loss in profit to the seller as the result of a negative externality. b. cost of an externality. c. cost reduction when the negative externality is eliminated. d. cost incurred by the government when it intervenes in the market.

b. cost of an externality.

Corrective taxes are typically advocated to correct for the effects of a. positive externalities. b. negative externalities. c. patents. d. All of the above are correct.

b. negative externalities.

University researchers create a positive externality because what they discover in their research labs can easily be learned by others who haven't contributed to the research costs. What could the federal government do to equate the equilibrium quantity of university research and the socially optimal quantity of university research produced? a. tax university researchers b. offer grants to university researchers c. eliminate subsidized student loans d. nothing

b. offer grants to university researchers

Refer to Figure 10-7. To internalize the externality in this market, the government should a. impose a tax on this product. b. provide a subsidy for this product. c. forbid production. d. produce the product itself.

b. provide a subsidy for this product.

Tradable pollution permits a. have prices that are set by the government. b. will be more valuable to firms that can reduce pollution only at high costs. c. are likely to create a higher level of total pollution. d.are less desirable than corrective taxes in reducing pollution

b. will be more valuable to firms that can reduce pollution only at high costs.

Which of the following illustrates the concept of a negative externality? a. A college professor plays a vigorous game of racquet ball with the racquet he recently purchased. b. A flood wipes out a farmer's corn crop. c. A college student plays loud music on his new stereo system at 2:00 a.m. d. A janitor eats a hamburger during his lunch break

c. A college student plays loud music on his new stereo system at 2:00 a.m.

Refer to Figure 10-4. Without government intervention, the equilibrium quantity would be a. Q1 b.Q2 c. Q3 d. Q4

c. Q3

The supply curve for a product reflects the a. willingness to pay of the marginal buyer. b. quantity buyers will ultimately purchase of the product. c. cost to sellers of producing the product. d. seller's profit from producing the product.

c. cost to sellers of producing the product.

Private markets fail to account for externalities because a. externalities don't occur in private markets. b. sellers include costs associated with externalities in the price of their product. c. decision makers in the market fail to include the costs of their behavior to third parties. d.the government cannot easily estimate the optimal quantity of pollution.

c. decision makers in the market fail to include the costs of their behavior to third parties.

If a sawmill creates too much noise for local residents, a. noise restrictions will force residents to move out of the area. b. a sense of social responsibility will cause owners of the mill to reduce noise levels. c. the government can raise economic well-being through noise-control regulations. d. the government should avoid intervening because the market will allocate resources efficiently.

c. the government can raise economic well-being through noise-control regulations.

Suppose that a steel factory emits a certain amount of air pollution, which constitutes a negative externality. If the market does not internalize the externality, a. the supply curve would adequately reflect the marginal social cost of production. b. consumers will be required to pay a higher price for steel than they would have if the externality were internalized. c. the market equilibrium quantity will not be the socially optimal quantity. d. producers will produce less steel than they otherwise would if the externality were internalized.

c. the market equilibrium quantity will not be the socially optimal quantity.

When externalities are significant and private solutions are not found, government may attempt to solve the problem through

command-and-control policies. market-based policies

If an externality is present in a market, economic efficiency may be enhanced by a. increased competition. b. weakening property rights. c. better informed market participants. d. government intervention.

d. government intervention.

Corrective taxes and subsidies

induce private decision makers to take account of the social costs that arise from a negative externality Places a price on the right to pollute Reduce pollution at a lower cost to society Raise revenue for the government Enhance economic efficiency

The Coase Theorem

is a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

private benefit

is the benefit derived by an individual or firm directly involved in a transaction as either buyer or seller

social benefit

is the total benefit to society from producing or consuming a good / service

Negative Externalities

lead markets to produce a larger quantity than is socially desirable When the impact on the bystander is adverse

Positive Externalities

lead markets to produce a smaller quantity than is socially desirable. When the impact on the bystander is beneficial; The social value of the good exceeds the private value

social cost

private cost plus externalities

externality

refers to the uncompensated impact of one person's actions on the well-being of a bystander.

Externalities cause markets

to be inefficient, and thus fail to maximize total surplus (aka market failure)

An externality arises

when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect.