Externalities homework

What must be true for the Coase Theorem to​ hold? For the Coase Theorem to​ hold, A. transaction costs to obtain an agreement must be high. B. the parties to an agreement cannot know the full cost of the externality. C. the government must monitor the negotiations to obtain an agreement. D. all parties to an agreement must be willing to accept a reasonable agreement. E. the externality must be positive.

D. all parties to an agreement must be willing to accept a reasonable agreement.

How might society solve problems associated with externalities and market failure? If an externality is​ present, resulting in market​ failure, then A. government intervention will further reduce the well−being of society. B. only government intervention can increase economic efficiency. C. it is not possible to enhance the well−being of society. D. additional competition will reduce problems associated with market failure. E. private solutions may reduce or correct market failure.

E. private solutions may reduce or correct market failure. In the presence of an​ externality, government intervention may actually increase economic efficiency and enhance the​ well-being of society. It is also​ possible, however, for people to find private solutions to the problem of externalities. In an important article written in​ 1960, Ronald Coase of the University of​ Chicago, winner of the 1991 Nobel Prize in​ Economics, argued that under some​ circumstances, private solutions to the problem of externalities will occur.

pigovian taxes and subsidies

Government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities.

Suppose the figure to the right illustrates the market for toilet​ paper, where S1 represents the marginal private cost of production and D1 represents the marginal private benefit from consumption. Companies that produce toilet paper bleach the paper to make it white. Some paper plants discharge the bleach into rivers and​ lakes, causing substantial environmental damage. Assume that S2 represents the marginal social cost of producing toilet paper​ (incorporating the​ externality). What could the government do to internalize the​ externality? In the presence of a negative​ externality, the government could ________ toilet paper production.

Tax A.C.​ Pigou, a British economist at Cambridge​ University, argued that to deal with a negative​ externality, the government should impose a tax. Pigou also argued that the government can deal with a positive externality by giving a subsidy.

Consider the market illustrated in the figure for wood from a forest. Suppose the trees are a common resource. Supply curve S1 represents the private cost of production and demand curve D1 represents the private benefit from consumption. Show how the private market overuses common resources. ​1.) Use the line drawing tool to first draw either a new supply ​(S2​) or demand ​(D2​) curve showing the true cost of cutting trees. Properly label this line. ​2.) Use the point drawing tool to indicate the actual price and quantity in the private market. Label this point​ 'Actual equilibrium'. ​3.) Use the point drawing tool to indicate the efficient equilibrium price and quantity. Label this point​ 'Efficient equilibrium'. Carefully follow the instructions​ above, and only draw the required objects.

The actual equilibrium is where the private cost and private benefit curves intersect. ​ However, for a common​ resource, such as trees in a forest​, the efficient level of use is determined by the intersection of the demand curve—which represents the marginal benefit received by consumers—and a new supply​ curve, which represents the marginal social cost of cutting trees. Because the marginal social cost is greater than the marginal private​ cost, the new supply curve is above the original supply curve representing the private marginal cost of production. That​ is, because the individuals who cut trees ignore the external cost of their​ actions, the actual equilibrium quantity is greater than the efficient quantity.

what is the case theorem?

The argument of economist Ronald Coase that if transaction costs are​ low, private bargaining will result in an efficient solution to the problem of externalities.

Consider the market illustrated in the figure to the right. Supply curve S1 represents the private cost of production and demand curve D1 represents the private benefit from consumption. Suppose the consumption of this good creates a negative externality.... In​ turn, the social benefit from consumption is represented by demand curve D2. Show how the externality affects market efficiency. Use the triangle drawing tool to shade in the new economic surplus​ (New surplus) or the deadweight loss​ (Deadweight loss) created by the negative externality. Properly label this shaded area. Carefully follow the instructions​ above, and only draw the required objects.

The market equilibrium is where the private cost and private benefit curves intersect. The efficient equilibrium is where the social cost and social benefit curves intersect. In this​ example, the private cost and social cost curves are equal. Notice that when there is a negative externality in​ consumption, too much of the good or service will be produced at the market equilibrium. This creates a deadweight loss equal to the area between the social benefit curve and the social cost curve for units produced at the market equilibrium but not at the efficient equilibrium.

public good

a good that is both nonrivalrous and nonexcludable

private good

a good that is both rival and excludable

quasi-public good

a good that is excludable but not rival

what is market failure?

a situation in which the market fails to produce the efficient level of output.

What is an externality?

an externality is a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service think of it as a side effect of production

what are property rights?

property rights are the rights individuals or businesses have to the exclusive use of their property including the right to buy or sell it

excludability

the situation in which anyone who does not pay for a good cannot consume it

rivalry

the situation that occurs when one person's consuming a unit of a good means no one else can consume it

what are transaction costs?

transaction costs are the costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services

Consider the market for a public good such asdams along a river​, illustrated in the figure to the right where S1 represents marginal private costs and D1 represents marginal private benefits. The dashed green line represents the corresponding marginal social benefit. The private market tends to ________ public goods. Use the triangle drawing tool to shade in the amount of deadweight loss created by the private market. Properly label this shaded area. Carefully follow the instructions​ above, and only draw the required objects.

under provide

Suppose a new recreational neighborhood park would cost​ $20,000, including opportunity​ costs, to construct and maintain. If​ built, the park would be a public good For​ simplicity, assume the neighborhood park would be used by three​ families, each of whom would derive a marginal benefit equivalent to​ $8,000 from the park. Should the neighborhood park be​ built? It ________ for the park to be built. If left to the private​ market, without private bargaining or government​ intervention, would the park be​ built? Without private bargaining or government​ intervention, the park _______ be built.

would be optimal would not

Qualifications for the Coase theorem

-low transaction​ costs -parties to the agreement must have full information about the costs and benefits associated with the​ externality -all parties must be willing to accept a reasonable solution.

Suppose the United States has two​ utilities, Commonweath Utilities and Consolidated Electric. Both produce 20 million tons of sulfur dioxide pollution per year.​ However, the marginal cost of reducing a ton of pollution for Commonwealth Utilities is ​$275 per ton and the marginal cost of reducing a ton of pollution for Consolidated Electric is ​$350 per ton. The​ government's goal is to cut sulfur dioxide pollution in half​ (by 20 million tons per​ year). If the government issues 10 million tradable pollution permits to each​ utility, what will be the cost of eliminating half of the pollution to​ society? Using a cap-and-trade system of tradable emission allowances will eliminate half of the sulfur dioxide pollution at a cost of ​______ million per year.

5,500 million With a​ cap-and-trade system of tradable emission​ allowances, utilities that can reduce emissions at low cost will do so and will sell their allowances. Utilities that can only reduce emissions at high cost will buy the allowances and will pollute. In this​ example, since Commonwealth Utilities can reduce pollution at lower cost ​($275 per ton versus ​$350 per​ ton), they will sell their 20 million permits and reduce sulfur dioxide by 20 million tons per year. The cost will be ​$5,500 ​million, from 20 million tons of pollution multiplied by the ​$275 cost of reduction per ton.

Suppose the figure to the right illustrates the marginal cost and marginal benefit from reducing sulfur dioxide pollution. Suppose also that the United States is currently generating 12.5 million tons of pollution per year. What is the optimal level of pollution​ reduction? The optimal level of pollution reduction is _____ million tons per year. ​(Enter your response rounded to one decimal​ place.)

8.5 million The net benefit to society from reducing pollution is equal to the difference between the benefit of reducing pollution and the cost. To maximize the net benefit to​ society, sulfur dioxide emissions—or any other type of pollution—should be reduced up to the point where the marginal benefit from another ton of reduction is equal to the marginal cost. The economically efficient reduction of sulfur dioxide emissions is 8.5 million tons per year. At that level of emission​ reduction, the marginal benefit and the marginal cost of the last ton of sulfur dioxide emissions eliminated are both ​$200 per ton.

what is a command-and-control approach

An approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices.

How do property rights affect externalities and market​ failure? A. Externalities will be positive and market failure will not occur when property rights are enforced. B. Externalities and market failure will result from incomplete property rights. C. Externalities and market failure will result from producers having all the property rights. D. Externalities will be positive and market failure will not occur when property rights are divided equally among market participants. E. Externalities and market failure will not occur when property rights are difficult to enforce.

B. Externalities and market failure will result from incomplete property rights. (or from the difficulty of enforcing property rights in certain situations.)

Consider a pair of Nike shoes. Is the consumption of Nike shoes rival and excludableLOADING...​? The consumption of Nike shoes is A. ​quasi-rival and​ quasi-excludable. B. nonrival and nonexcludable. C. rival and excludable. D. nonrival and excludable. E. rival and nonexcludable.

C. rival and excludable.

In​ particular, the government should set a Pigovian tax of _______ per ton of toilet paper produced.

$225 A.C.​ Pigou, a British economist at Cambridge​ University, argued that to deal with a negative​ externality, the government should impose a tax equal to the cost of the externality. The cost of the externality equals the size of the vertical distance between the marginal private cost and marginal social cost curves. In this​ example, the government would need to set a Pigovian tax equal to ​$225 to internalize the externality caused by toilet paper production.

Suppose that the use of fish in public water generates a negative externality of ​$75 per unit. If​ so, then according to the​ figure, the optimal quantity of fish in public water for society is ______ units. ​(Enter your response as an​ integer.)

6 units

cap-and-trade system

A system of tradable emission allowances. The federal government gave utility companies allowances equal to the total amount of allowable sulfur dioxide emissions and allowed companies to buy and sell them on the Chicago Mercantile Exchange. Utility companies that can reduce their emissions at low cost have done so and then sold their allowances. Those utility companies that can only reduce their emissions at high cost have purchased the allowances.

Suppose the production of electricity by a utility generates pollution that harms others. Suppose also that Coase bargaining can occur between the utility and the victims of pollution but that the utility has not been legally liable for the damages from its pollution. How would making the utility legally liable for the damages from its pollution affect pollution​ reduction? If the electric utility and the people suffering the effects of the​ utility's pollution can​ bargain, then making the utility legally liable for the damages from its pollution will A. not change the amount of pollution reduction because the marginal benefit and marginal cost of pollution reduction will not change. B. increase the amount of pollution reduction by increasing the marginal benefit of pollution reduction to the utility. C. increase the amount of pollution reduction by decreasing the marginal cost and increasing the marginal benefit of pollution reduction to the utility. D. increase the amount of pollution reduction by increasing the marginal benefit of pollution reduction to the victims of pollution. E. increase the amount of pollution reduction by increasing the marginal cost of pollution reduction to the utility.

A. not change the amount of pollution reduction because the marginal benefit and marginal cost of pollution reduction will not change. In the absence of the utility being legally​ liable, the victims of pollution have an incentive to pay the utility to reduce pollution up to the point where the marginal benefit of the last ton of reduction is equal to the marginal cost. If the utility is legally​ liable, it has an incentive to pay the victims of pollution to allow it to pollute up to the same point.​ Therefore, property rights​ (and legal​ liability) do not matter for the amount of pollution reduction because such rights​ (and such​ liability) do not change the marginal benefits and the marginal costs of pollution reduction.

Suppose the figure to the right illustrates the marginal cost and marginal benefit from reducing sulfur dioxide pollution. How could the government use a command-and-control approach to reduce pollution to the optimal level for​ society? The government could A. prohibit sulfur dioxide pollution entirely. B. limit sulfur dioxide pollution to a particular quantity per year. C. subsidize each ton of sulfur dioxide pollution. D. reduce transaction costs to encourage private solutions to the problems associated with sulfur dioxide pollution. E. tax each ton of sulfur dioxide pollution.

B. limit sulfur dioxide pollution to a particular quantity per year. In this​ example, the government could impose a quantitative limit on the amount of pollution firms are allowed to generate such that 7.0 million tons of pollution are reduced.

How do externalities in the production of electricity result in market failure​? Because of​ externalities, the market for electricity will A. result in a surplus of electricity. B. provide too much electricity. C. provide insufficient electricity. D. generate too much economic surplus. E. result in a price for electricity that is inefficiently high.

B. provide too much electricity. Externalities result in market​ failure, which is a situation where the market fails to produce the efficient level of output. For​ example, in the market for electricity​, a negative externality results in the market providing too much electricity because the market does not account for the cost of electricity on others.

How do externalities... affect​ markets? If a negative externality in production is present in a​ market, then A. the private benefit from consumption will be different than the social benefit from consumption. B. consumer and producer surplus will be maximized. C. the social cost of production will be equal to the social benefit from consumption. D. the private cost of production will be different than the social cost of production. E. the private cost of production will be equal to the private benefit from consumption.

D. the private cost of production will be different than the social cost of production. Private cost is the cost borne by the producing of a good or​ service, and social cost is the total cost of producing a good or​ service, including both the private cost and any external cost. If there is a negative externality, private cost and social cost will not be equal.

Consider the consumption of national defense. What type of good is national defense​? National defense is A. a quasi−public good. B. a private good. C. an externality. D. a common resource. E. a public good.

E. a public good. National defense is a public good because it is nonrival and nonexcludable.

Suppose the figure to the right illustrates the marginal cost and marginal benefit from reducing sulfur dioxide pollution. Suppose also that the United States is currently planning to eliminate 5.5 million tons of pollution per year. What would be the net benefit to the United States of instead eliminating 8.5 million tons of sulfur​ dioxide? Use the triangle drawing tool to shade in the net benefit to society from eliminating 8.5 million tons of pollution per year compared to eliminating 5.5 million tons of pollution. Label this shaded area​ 'Net benefit'. Carefully follow the instructions​ above, and only draw the required objects.

The benefit to society of reducing pollution is equal to the area under the marginal benefit curve. The cost to society of reducing pollution is equal to the area under the marginal cost curve. The net benefit to society from reducing pollution is equal to the difference between the total benefit of reducing pollution and the total cost. ​Therefore, the net benefit to society of reducing pollution by an additional 3.0 million tons per year is the difference in the marginal benefit and marginal cost curves for pollution reduction between 5.5 million and 8.5 million tons per year.

common resource

a good that is rival but not excludable

Consider the market for fish in public water​, illustrated in the figure to the​ right, where S1 is marginal private cost and D1 is marginal private benefit. Fish are an example of a __________.

common resource

Suppose the United States has two​ utilities, Commonweath Utilities and Consolidated Electric. Both produce 20 million tons of sulfur dioxide pollution per year.​ However, the marginal cost of reducing a ton of pollution for Commonwealth Utilities is ​$275 per ton and the marginal cost of reducing a ton of pollution for Consolidated Electric is ​$350 per ton. The​ government's goal is to cut sulfur dioxide pollution in half​ (by 20 million tons per​ year). If the permits are not​ tradable, what will be the cost of eliminating half of the​ pollution? If permits cannot be​ traded, then the cost of the pollution reduction will be ​$_____million per year.

6250 million If the pollution permits cannot be​ traded, then both utility companies will eliminate 10 million tons of sulfur dioxide emissions. This reduction will cost Commonwealth Utilities ​$2,750 ​million, from 10 million tons of pollution multiplied by the ​$275 reduction cost per​ ton, and it will cost Consolidated Electric ​$3,500 ​million, from 10 million tons of pollution multiplied by the ​$350 reduction cost per ton. The total cost of reducing sulfur dioxide by 20 million tons per year will be ​$6,250 million.

In England during the Middle​ Ages, each village had an area of​ pasture, known as a​ commons, on which any family in the village was allowed to graze its cows or sheep without charge. Was the common land used​ optimally? A. The commons was overused because the commons was an excludable good. B. Grazing created a negative​ externality, resulting in the commons being overused. C. The commons was used optimally because the commons was a rival good. D. Grazing created no​ externality, resulting in the commons being used optimally. E. The commons was underused due to free riding.

B. Grazing created a negative​ externality, resulting in the commons being overused. The commons ended up overgrazed. For​ example, a family thinking of buying another cow and grazing it on the commons would gain the benefits from increased milk​ production, but adding another cow to the commons would create a negative externality by reducing the amount of grass available for the cows of other families. Because this family—and the other families in the village—did not take this negative externality into account when deciding whether to add another cow to the​ commons, too many cows were added. The grass on the commons was eventually​ depleted, and no​ family's cow got enough to eat.

Suppose the government requires each firm to reduce sulfur dioxide emissions by an equal amount such that total emissions are reduced by 7.0 million tons per year. Is this approach necessarily economically​ efficient? This​ command-and-control approach A. is not efficient because some firms may still be generating pollution. B. is not efficient because firms can have different costs of reducing pollution. C. is efficient because it does not require the government to know the​ firms' cost of reducing pollution. D. is efficient because each firm is reducing pollution by the same amount. E. is efficient because reducing sulfur dioxide pollution by 7.0 million tons per year is where the marginal cost and marginal benefit of pollution reduction are equal.

B. is not efficient because firms can have different costs of reducing pollution. Some firms may already use​ low-sulfur coal and can reduce emissions further only at a high cost. Other utilities may be able to reduce emissions at a lower cost.​ Therefore, a​ command-and-control approach that requires each firm to reduce pollution by the same amount may not be an economically efficient solution to the problem of externalities because the same amount of pollution could be eliminated at lower cost.

How might transaction costs affect private solutions to externality​ problems? Transaction costs A. may make private solutions to reduce negative externalities easier. B. do not affect private solutions to reduce negative externalities. C. may make private solutions to reduce negative externalities unnecessary. D. may provide additional incentive for private solutions to reduce negative externalities. E. may make private solutions to reduce negative externalities no longer feasible.

E. may make private solutions to reduce negative externalities no longer feasible. In the case of​ externalities, transaction costs would include the time and other costs of negotiating an​ agreement, drawing up a binding​ contract, purchasing​ insurance, and monitoring the agreement. Transaction costs may be higher than the net benefit from reducing a negative externality. In such​ cases, a private solution to an externality problem is not feasible.

Which of the following is an example of a transaction cost associated with negotiating the reduction of a negative​ externality? An example of a transaction cost is A. the marginal cost of reducing a negative externality. B. the cost associated with not reducing a negative externality. C. the total cost of reducing a negative externality. D. the cost of a negative externality on others. E. the cost associated with drawing up a binding contract to reduce a negative externality.

E. the cost associated with drawing up a binding contract to reduce a negative externality. In the case of​ externalities, transaction costs would include the time and other costs of negotiating an​ agreement, drawing up a binding​ contract, purchasing​ insurance, and monitoring the agreement.

Consider the market illustrated in the figure to the right. Supply curve S1 represents the private cost of production and demand curve D1 represents the private benefit from consumption. Suppose consumption of this good creates a positive externality. Show how the externality affects the market. ​1.) Use the line drawing tool to draw either a new supply ​(S2​) or demand ​(D2​) curve incorporating the positive externality in consumption. Properly label this line. ​2.) Use the point drawing tool to indicate the market equilibrium price and quantity. Label this point​ 'Market equilibrium'. ​3.) Use the point drawing tool to indicate the efficient equilibrium price and quantity. Label this point​ 'Efficient equilibrium'. Carefully follow the instructions​ above, and only draw the required objects.

d2= marginal social benefit