ECON-2302 Inquizitive Ch. 7 - Market Inefficiencies - Externalities & Public Goods
A new chocolate factory is built in a small town. Residents love the smell that emanates from the chocolate production, and tourists like to buy candy from the factory's retail shop. Tourists can also pay a small fee to take factory tours and taste some of the chocolates. Which of the following statements about the chocolate factory are accurate?
Accurate ~The factory should permit the town's visitors center to sell discounted tickets for the chocolate tastings [Selling discounted tickets will encourage more visitors both to the town and to the factory. More chocolate will be consumed and produced] ~The factory will increase tourist business for owners of shops and restaurants in the town [The increase in the number of tourists to the town represents external benefits for local business owners] Inaccurate ~Without government intervention, the factory produces too much chocolate [When positive externalities exist in a market, there is underproduction of the good or service] ~The town government should tax the production of chocolate [A tax will discourage chocolate production and lead to less chocolate being produced]
Which of the following correctly describes a subsidy?
Describes a Subsidy ~a means of internalizing positive externalities [Without the subsidy, the positive externality would not be internalized by consumers] ~a consumption incentive [The subsidy gives consumers a reason to consume more] Does Not Describe a Subsidy ~a tax on producers [A subsidy is money from the government, not money to] ~a way of making consumption cost-free [Some subsidies cover the entire cost of consumption, but it is not typical] *[Subsidies encourage consumers to buy products and services that benefit third parties]
Classify each activity involving common property as neglect, overuse, or neither.
Hundreds of people set off fireworks on the beach at night leaving all of the packaging and spent fireworks on the beach ~both neglect and overuse [This is both neglect and overuse because of the trash left on the beach and the amount of people setting off fireworks] In a national park, all wildfires are immediately put out ~neither [Aggressive fire prevention may not be ideal policy, but it is not neglect or overuse] No one takes care of decorative plants planted in a city park ~neglect [Maintaining a piece of public or common property would include watering and fertilizing plants in a public park] Redwood trees in a park become unhealthy due to heavy foot traffic at their base ~overuse [Since the damage is due to the high volume of visitors, this is a case of overuse] Logging removes timber faster than it can grow back ~overuse [This is clearly a case of overuse] *[The two main problems with common-resource goods are the incentive to neglect and the incentive to overuse]
A rancher's cattle is getting into a farmer's wheat. The farmer is displeased because a low-cost barbed wire fence could be constructed to fix this problem. What does the Coase theorem predict could happen, depending on what property law says about the farmer's right to his cropland? More than one choice may be correct.
Prediction by the Coase Theorem ~The rancher pays to build a fence [If the farmer has a legal right to expect his land to be cattle-free, the rancher must pay for the fence] ~The farmer pays to build a fence [If the farmer has no legal right to cattle-free land, he must pay for any fence] Not a Prediction by the Coase Theorem ~The fence does not get built [The Coase theorem predicts that since a fence is in the farmer's interest, he will build the fence if the rancher cannot be induced to do it] ~The government pays for the fence [The Coase theorem describes the natural resolution of such cases without government intervention] *[Either the rancher or the farmer may be obliged to pay for any fence, depending on property law]
Why does a campground at a national park not necessarily count as a public good?
Reason ~The park may charge a fee for overnight camping [The fee makes the good excludable] ~The number of camping spaces may be limited [A limited number of spaces makes the campground a rival good] Not a Reason ~The park is government owned [Not all public goods are government owned, and not everything government owned is a public good] ~The campground competes with private campgrounds [The existence of privately managed alternatives does not matter one way or the other]
Well-defined property rights can lead to the better maintenance and care of a good. In which of the following scenarios would property rights (or lack thereof) lead individuals to fix the problem themselves and for which scenarios would they likely neglect the problem?
Solves the Problem ~A homeowner spills tomato sauce on the carpet [The homeowner would have to pay for the damaged carpet] ~Sports fans celebrate a victory by spraying foam on cars in the parking lot [The cars are private property, so the owners of the cars will have an incentive to clean their own cars after the celebrations are over] Neglects the Problem ~People throw trash out the window while driving [No one owns the roads or highways that people drive along] ~A dog walker does not clean up after his dog on a neighborhood trail [The neighborhood trail is communal property] ~Students leave trash on cafeteria tables after lunchtime [The school, not the students, owns the tables] *[When people have well-established property rights, they are incentivized to take care of their property]
What are ways the government can prompt a producer to internalize pollution costs that were previously external?
Way to Prompt a Producer ~mandated coverage of cleanup costs [The expense of cleaning up pollution gives a reason not to pollute in the first place] ~pollution taxes [A tax on pollution is an incentive not to pollute] ~pollution abatement regulations [Costs to the environment are replaced with costs associated with filtering, monitoring, and so on] Not a Way to Prompt a Producer ~consumer subsidy for clean products [This is more properly considered an action on the consumer side, not the producer side] *[To internalize an external cost is simply to arrange for the burden of the cost to fall (at least partly) on the responsible party]
Several ways exist to reduce the overuse or neglect of common resources. Match each situation with the correct method for eliminating the tragedy of the commons.
a fee to play on a golf course ~creating a club good [The fee makes the golf course excludable to those who do not pay] a toll on a congested bridge ~creating a club good [Individuals who don't pay the toll cannot cross the bridge] a fine for littering in a public park ~government regulation [The fine is designed to discourage littering] increasing fuel-emissions standards for automobiles ~government regulation [The standards are designed to reduce air pollution] *[Government regulations result in direct penalties or specific requirements for the use of common resources. Club goods make common resources excludable]
Match each label to the good it fits best.
a free public parking space ~rival [If you park in a parking space, that means that space is no longer available to be used by someone else] the air we breathe ~public [You don't have to pay for air, and the air is breathed by billions of people at the same time] an amusement park ~excludable [Entering an amusement park requires paying an entry fee. Excludable goods are goods that the consumer must purchase before using] *[Private goods are excludable by definition, since the law enables the owner to take action against unauthorized users]
For the problems of overfishing of Alaskan king crab, match each action to the problem it addresses.
fishing boats taking too many crabs ~limits on catch number [A per-boat quota controls the impact of fishing on the crab population] Harvest of females and juveniles breaks the reproductive cycle ~sex and age limits on catch [Protection of juveniles and females safeguards the reproductive viability of the population] Populations do not have enough time during the off-season to recover ~shorter fishing season [A short fishing season gives the crab population time to reproduce. It also limits the number of crabs taken in the first place] *[Timely intervention has in fact prevented the Alaskan king crab population from suffering the same population collapse as the Atlantic cod]
Private property rights create incentives. Match each type of incentive to a corresponding example.
keeping a motor home in a locked enclosure ~protecting property [Protecting property means guarding against theft and damage] selling a used motor home on Craigslist ~trading with others [Trade transfers a good, along with its value, from one owner to another] making regular oil changes on a motor home ~maintaining property [Oil changes help prolong a motor home's functional lifespan] using a motor home only for vacation trips, not commutes and errands ~conserving property [Conserving property means not using it up unnecessarily] *[All four incentives are a function of well-established private property rights]
Match each type of good to the corresponding description.
many can use even if few or none pay for it ~public [Public goods can be consumed by more than one person, and non-payers are hard to exclude] More for one consumer means less for others ~rival [Rival goods cannot be used by many people without detracting from each consumer's benefit] consumer must pay for ~excludable [Excludable goods are not available to those who have not paid] paid for and used by owners only ~private [Private goods are both excludable and rival] *[Private and public goods are opposite: private goods are excludable and rival, while public goods are neither]
Consider the characteristics of each of the goods or services below under normal day-to-day market conditions. Place each good or service onto the correct quadrant of the table.
private goods (rival & excludable) ~bread ~coffee ~television sets club goods (nonrival & excludable) ~broadband Internet ~water from a drinking fountain in a member-only sports gym ~cable television common-resource goods (rival & non-excludable) ~the atmosphere ~a major river ~a community garden public goods (nonrival & non-excludable) ~national defense ~aesthetically pleasing architecture ~a large sculpture in a city square *[Excludability and rivalry are what determine whether a good is a private good, club good, common-resource good, or a public good]
What is the definition of an externality?
~a cost or benefit of market activity to an outside party [An outside party is commonly called a third party]
The Great Pacific Garbage Patch is an example of a type of market failure known as the underproduction of a public good.
~false [Clean ocean water is rival in consumption, so the ocean is a common resource. The Great Pacific Garbage Patch is an example the overuse typically found in the tragedy of the commons]
Identify the beneficial effects of copyright law, in terms of addressing the free-rider problem.
Beneficial Effect ~It allows artists to legally prevent others from using their work without their permission and/or payment [Piracy is still possible, but copyright law discourages it and gives artists legal recourse] ~It effectively turns content from a public good into a club good [With copyright, the nonrival content is now excludable] ~It makes certain goods excludable [The goods are nonrival, but the law makes the content excludable] Not a Beneficial Effect ~It limits competition among artists [Copyright law may limit competition, but this is not a beneficial effect] ~It permits encryption of content [The use of encryption does not depend on copyright law, although encryption is often used to protect copyrighted material] *[Copyright law recognizes and governs the reciprocal relationship that exists between artists and their audience: each side needs the other]
What are some circumstances under which the Coase theorem fails to apply?
Coase Theorem Fails to Apply ~The externality is smaller than the transactions cost associated with negotiating an agreement [An externality will not be internalized if the cost of doing so would exceed the cost of the externality] ~Many individuals are impacted [Negotiation is not practical when too many parties are involved] ~The two parties are unable to communicate [The Coase theorem assumes no barriers to negotiation. A language barrier, for instance, would block effective negotiation] ~No applicable property law exists [The Coase theorem assumes clear property rights] Coase Theorem Applies ~Property law is clear about everyone's position [This is exactly the kind of situation the Coase theorem applies to] *[The Coase theorem applies whenever property rights are fully specified, there are no barriers to negotiation, and the externality is large enough to be worth internalizing]
Enforceable property rights would encourage you to maintain a car in good condition. Which factors contribute to this situation?
Contributing Factor ~The incentive to maintain property [Car owners have an incentive to maintain their vehicles. Routine maintenance, replacement of worn parts, and repairs keep the vehicle safe and reliable. In addition, a well-maintained car can be sold for more than one in poor condition] ~The incentive to trade with others [Car owners have an incentive to trade with others because they may profit from the transaction] Not a Contributing Factor ~The incentive to neglect property [Owners have an incentive to protect their vehicles from theft or damage. They protect their property by using alarm systems, locking the doors, and parking in well-lit areas] ~The incentive to overuse property [Car owners also have an incentive to extend the usable life of their automobiles by limiting the number of miles they put on their cars each year]
Which incentives come with owning private property?
Incentive ~the incentive to trade the property for something more valuable to the owner in the market [If the property owner can profit from trading his or her private property for something else in the market, they are incentivized to do so] ~the incentive to maintain the condition of the property [Property that is poorly maintained is less valuable] ~the incentive to conserve the property [Certain goods may not last their full expected lifespan if not conserved carefully by the owner] ~the incentive to protect property [The property owner bears all costs for private property that is lost, damaged, or stolen] Not an Incentive ~the incentive to share the property with others [In general, property ownership brings with it the right to exclusive use] ~the incentive to use the property in a manner that is optimal for society [Property rights give owners the ability to exercise control over a resource, providing them with incentives to use their property in ways that make them happy]
Imagine that a politician has been asked to support the public good proposals below. In order not to waste money and improve her chances of reelection, she makes her decisions based on a cost-benefit analysis. In each of the situations, should she support or reject the proposal?
Support the Proposal ~installing streetlights in a community where there has been a lot of crime [If installing streetlights will reduce crime, then the benefits will likely outweigh the costs] ~repairing a broken dam that is a major source of hydroelectric power for a large city [The benefits may outweigh the costs to repair the dam if the dam improves the efficiency of providing electricity to the city] Reject the Proposal ~building a very expensive flood control system for an area that floods once every 10,000 years [The costs would likely outweigh the benefits because the likelihood that a flood large enough to damage the area would occur is 1/10,000 for any given year] ~fixing a pothole along a lightly used street [If the road is used only lightly, the costs of fixing the pothole may exceed the benefits because people can drive around the pothole] *[When politicians consider the costs and benefits of providing a public good, they will support it when the benefits of the good outweigh the costs of paying for it]
A firm produces a good that generates a large amount of pollution. The government is considering whether to force the firm to internalize the external cost of pollution by imposing stricter pollution control requirements. Place the labels in the correct locations on the graph, which depict the market and socially optimal equilibria before the introduction of antipollution regulations.
area above yellow triangle b/w blue slope & red slope ~socially optimal equilibrium [The socially optimal equilibrium price is higher than the market equilibrium price] area on yellow triangle ~deadweight loss dot on blue slope & light red slope ~market equilibrium [The equilibrium price is lower than the socially optimal equilibrium price] area left of gray dotted lines ~QSocially optimal [The socially optimal quantity is less than the market equilibrium quantity] area right of gray dotted lines ~QMarket [The market equilibrium quantity is greater than the socially optimal equilibrium quantity] *[If the production of a good tends to cause pollution, then antipollution regulations could shift the supply curve leftward, meaning that less will be produced at the social optimum when the externality is internalized]
A city concerned about water consumption would like homeowners to replace their lawns with low-water-consumption landscaping. To encourage this, the county is considering offering a subsidy of $2 per square foot of lawn replaced, thereby causing homeowners to internalize the community benefit of water conservation. The graph depicts the supply and demand for drought-tolerant shrubs. Place the labels in the correct locations on the graph, which depict a future shift in market equilibrium as a result of the subsidy.
dot on light blue slope ~market equilibrium [The equilibrium price and quantity would be lower without the subsidy] dot on dark blue slope ~socially optimal equilibrium [The equilibrium price and quantity would be with the subsidy] yellow triangle area ~deadweight loss area left of gray dotted line ~QMarket [The market equilibrium quantity with no subsidy would be less than the socially optimal equilibrium quantity] area right of gray dotted line ~QSocial optimum [The new equilibrium quantity would be greater than the old one]
All of the residents of a subdivision have been experiencing a particularly bad problem with mosquitoes. The problem affects all the residents, but only a few residents have had their lawns professionally sprayed for mosquitoes. The subdivision has a mandatory homeowners association, and they vote to use some of the association dues to subsidize the costs for residents who would like to have their properties sprayed. Match each statement about the effects of the subsidy to the correct graph for the mosquito-spraying market. Click on the graphs to enlarge.
graph w/ two blue slopes ~Neighborhood visitors will receive fewer mosquito bites [Third parties will experience benefits from the mosquito spraying] ~The Dinternal curve will shift toward the Dsocial curve [The vouchers will encourage more residents to purchase mosquito-spraying services] ~The deadweight loss of mosquito spraying will be reduced or eliminated [The market quantity will shift closer to the socially optimal quantity] graph w/ two red slopes ~Chemicals from the mosquito spray may leach into the groundwater [Third parties may experience external costs from water pollution]
Place each definition, corrective measure, and example in the appropriate location.
negative externalities (definition) ~costs borne by third parties negative externalities (corrective measures) ~taxes or regulation negative externalities (examples) ~Airports create noise pollution positive externalities (definition) ~benefits received by third parties positive externalities (corrective measures) ~subsidies or government provision positive externalities (examples) ~Restored historic buildings enable people to enjoy beautiful architectural details
Complete the table below by placing each example in the correct column.
no externalities/no costs or benefits borne by 3rd parties ~a college student purchases a computer ~a consumer buys a sandwich ~homeowner redecorates his/her living room negative externalities/costs borne by 3rd parties ~almost every student on campus eats lunch in the campus food court at the same time, causing congestion in the food court ~a freight train near a dorm wakes students up every night at 2 a.m. ~a local paper plant releases foul-smelling but otherwise harmless exhaust positive externalities/benefits received by 3rd parties ~fans of the local football team pay for a large statue of the team's mascot ~college freshmen are required to receive vaccinations before classes begin ~owners of historic homes pay to restore and maintain their homes, which other people enjoy looking at *[If a spillover effect is a cost, it is a negative externality. If the spillover effect is positive, it is a positive externality]
Vaccinations create a positive externality for society beyond the benefits to just the person who chooses to get vaccinated. In fact, society as a whole also benefits when people get vaccinations. If enough people get vaccinated in a society, it will slow down the spread of a virus substantially, which will benefit others who do not get the vaccination—what is called herd immunity. However, getting vaccinated is an individual decision and because when making decisions people take into consideration only their internal or private benefits, society as a whole does not get to the socially optimum level. The graph below illustrates this point. Place the labels in the correct locations on the graph based on your knowledge of positive externalities.
point on light blue slope ~Emarket [Because consumers are not internalizing all the benefits of a vaccine, they will tend to underconsume the vaccine, which is why Emarket will always be less than Esocial for goods that have a positive externality] point on dark blue slope ~Esocial [This quantity is the socially optimal amount of vaccines that would make society better off. To get to this quantity, the government often offers subsidies to help lower the costs] light blue slope ~Dinternal [This curve represents the personal, or internal, benefits you receive when you get vaccinated. For example, you will be less likely to get the virus, and you will have greater confidence going out in public knowing you are safe] dark blue slope ~Dsocial [This curve represents both the internal, or private, benefits and the externalities associated with getting vaccinated. For example, the airline industry has a lot to gain when consumers start to travel again]
Place each of the four goods listed in the appropriate location in the graph.
private goods (rival & excludable) ~telephone (home landline) [Owner pays, owner has sole use] club goods (nonrival & excludable) ~toll road (non-congested) [There is a usage fee, but there is room for everyone who wants in] common-resource goods (rival & non-excludable) ~freeway (rush hour) [No usage fee, but everyone is in someone else's way] public goods (nonrival & non-excludable) ~non-password protected, public Wi-Fi (where there is plenty of bandwidth) [There is no usage fee, and everyone is able to log on] *[The classification of a good depends on part on the situation in which use occurs. A roadway may be rival or nonrival, depending on how crowded it is]
Identify each example of a cost as an internal cost or an external one.
surcharge to recycle your old tires when buying new tires ~internal [The tire user pays the surcharge] low river level due to heavy upstream use of the water for crops ~external [The cumulative effect of the heavy upstream use of the river water is felt downstream from where the water is extracted from the river] sunburn after a day at the fair ~internal [The fairgoer gets the sunburn] jet noise near an airport ~external [Those living near an airport deal with the noise even if they never fly] *[Internal costs are paid by participants in a market transaction. External costs are paid by nonparticipants]
Place the events in order to explain how a public good comes to be undersupplied.
~a team of volunteers spends weekends removing unwanted graffiti in public spaces ~many merchants and citizens benefit and verbally express their gratitude ~when those who expressed thanks are asked to support the effort with a voluntary financial contribution, only a few do so ~lacking the funds to pay for supplies and transportation, the volunteer team eventually quits
Fill in the blanks to complete the description of public goods. The market for public goods such as - often subject to -. Private markets tend to - these goods and services because of the - problem. One solution to this problem is for - to use people's - dollars to provide for public goods.
~city parks ~market failure ~undersupply ~free-rider ~governments ~tax *[The private equilibrium for public goods is less than the socially optimal level. Public-sector provision of these goods through the use of tax revenue increases supply and reduces the free-rider problem]
Which of the following would need to be true for Internet access to qualify as a club good?
~connection speed does not depend on number of current users [Club goods are by definition nonrival]
Classes at state-run public universities are a public good.
~false *[While public universities are largely funded by the government, the funding source for a good or service does not determine whether the good is a public good. A public good is defined as a good that is nonrival and nonexcludable]
A college professor requires students to complete group presentations. She is trying to decide on a grading system that will minimize the free-rider problem. Order the following grading systems from the system that is the least likely to have free-riders to the system that is the most likely.
~group members complete an individual paper on the group topic that counts as a large part of an individual's final project grade [Because each group member must complete an individually written paper, this scheme creates an incentive for all group members to pull their weight] ~group members must assign roles for each part of the project, and all members receive the same final project grade [Because all students receive the same benefit regardless of work output, some group members may have less incentive to pull their weight]
Fill in the blanks to complete the sentence describing ways of encouraging vaccination. In order to maximize everyone's - benefits, schools can require proof of vaccination from their students, and - often provide - to lower the cost of vaccines for -.
~health ~governments ~subsidies ~consumers *[Subsidies are a way of internalizing for each consumer the external benefit to others when he or she is vaccinated]
Strictly from an economist's perspective, which of the following is not a problem with cap and trade policy?
~high-cost producers are able to buy their way out of the problem rather than having to reform [From a moral perspective, this may be a problem. But from an economist's perspective, cap and trade still leads to the desired reduction in pollution and therefore tends to lead to a more optimal arrangement]
What negative externalities might hydraulic fracturing ("fracking") for natural gas generate?
~increased risk of pollutants in the water, affecting those who live near wells [Chemicals used in fracking can seep into groundwater and pollute wells]
Identify the best explanation for why national defense is a public good.
~it is not feasible for a nation to defend only selected people who pay for defense against invasion [A nation is responsible for defending its borders. It cannot reasonably choose to defend only selected people or areas within its borders. This makes national defense nonexcludable]
Fill in the blanks to complete the statement about how people treat property. When a good belongs to -, it tends to -. That is the problem - exist to solve. A good belonging to - tends to be handled -.
~no one in particular ~deliver less value ~property rights ~a specific person ~more efficiently *[We look after things we own and are responsible for, more than we do things that belong to someone else or no one in particular]
Fill in the blanks to complete the passage about the tragedy of the commons. In 1968, Garret Hardin wrote about a hypothetical pasture being ruined by -. The cause was - ownership that gave each herder - to use the pasture and - to exercise restraint. One solution for this kind of situation would be a change in the - of the commons.
~overuse ~common ~an incentive ~no incentive ~property status *["Tragedy of the commons" has become a catchphrase for the problem of preserving public goods against ruin through overuse]
Which class of goods generally gives rise to free-rider problems?
~public goods [Public goods are nonexcludable, which is why free-rider problems arise]
Fill in the blanks to complete the passage about common-resource goods. Common-resource goods are - and also non--. Together with -, they represent a kind of middle ground between - and public goods. A typical example would be any marketable ocean-dwelling fish, since - is not practical and fish stocks are -.
~rival ~excludable ~club goods ~private goods ~exclusion ~depletable
What would be a reason for a government not to intervene with a particular externality?
~the externality is not large enough to justify the costs of intervening [These costs might include administrative expenses and a regulatory burden on producers]
Fill in the blanks to complete the description of common property. Under a system of common property, - leads to - and overuse. The phrase tragedy of the commons has been used to describe this type of situation.
~the incentive structure ~neglect *[Note the difference between the free-rider problem, which typically is one of underproduction, and the tragedy of the commons, which typically is one of overuse]
Which of the following is an example of the tragedy of the commons?
~the state of a public restroom on campus at the end of the day [A clean public restroom is a common resource. There is no incentive to keep it clean]
What is a main problem with determining the social benefits of a public good like a community fireworks show?
~there is no definitive way to find out how much people like fireworks [Surveys are not reliable, and since people do not pay to watch fireworks, there is no market pricing mechanism]
All externalities are market failures, but not all market failures are externalities.
~true [A market failure occurs whenever resources are allocated inefficiently in a market. Externalities, like water pollution, are one type of market failure, but the underprovision of public goods is another type of market failure]
A negative externality is the same thing as an external cost.
~true [An externality is an external cost (negative) or benefit (positive)]
Cap and trade policy in effect makes the right to pollute a tradable good.
~true [Government-issued permits set a limit on permitted pollution, and those permits can be bought and sold]
The incentive to trade is different from the other three property incentives (to maintain, to protect, to conserve) because the others are about safeguarding value, while trading is about allocating it.
~true [The incentive to trade tends to place a good in the hands of the person who values it most. The other three incentives are about maintaining the value of a good under its present owner]
A series of events takes place when an externality is internalized. Place the events in logical order.
~widespread use of residential woodstoves affects air quality ~new regulations impose emission limits on all new woodstoves ~makers update woodstove designs ~the costs of implementing the design changes are partly borne by makers and partly passed on to consumers ~air quality improves as the new woodstoves come into use *[A similar sequence will occur with any consumer product targeted by pollution-reduction regulation]
