ECO2023 Ch 10 Externalities

When an individual buys a car in a congested urban area, it generates

a negative externality.

A negative externality generates

a social cost curve that is above the supply curve (private cost curve) for a good.

The gas-guzzler tax that is placed on new vehicles that get very poor mileage is an example of

an attempt to internalize a negative externality.

When wealthy alumni provide charitable contributions to their alma mater to reduce the tuition payments of current students, it is an example of

an attempt to internalize a positive externality.

All externalities

cause markets to fail to allocate resources efficiently.

The difference between social cost and private cost is a measure of the

cost of an externality.

An externality is

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

A negative externality (that has not been internalized) causes the

equilibrium quantity to exceed the optimal quantity.

Which of the following statements is correct? a. The private cost of producing the 160th unit of output is $16. b. The social cost of producing the 160th unit of output is $22. c. The external cost of producing the 160th unit of output is $6. d. All of the above are correct.

All of the above are correct.

What are the sources of transaction costs when affected parties try to eliminate an externality?

Lawyers' fees, costs of enforcement, a breakdown in bargaining when there is a range of prices that would create efficiency, and a large number of interested parties.

An alternative label for the quantity Q2 would be

Q OPTIMUM

T/F A corrective tax sets the price of pollution while tradable pollution permits set the quantity of pollution.

TRUE

Suppose citizens living around Metropolitan Airport value peace and quiet at a value of $3 billion. If it costs the airlines $2 billion to make their planes quieter, is it efficient for the government to require that the planes be muffled? Why or why not?

Yes, because the value placed on peace and quiet exceeds the cost of muffling the planes.

If the production of a good yields a negative externality, then the social-cost curve lies ________ the supply curve, and the socially optimal quantity is ________ than the equilibrium quantity.

above; less

Gretchen is a writer who works from her home. Gretchen lives next door to Randall, the trumpet player for a local band. Randall needs lots of practice to earn his share of the band's profit, which will amount to $350. Gretchen gets distracted by Randall's trumpet playing but she needs to get her writing done to earn $570 for her current article. If Randall owns the right to play his music and Gretchen needs to hire a lawyer to help her reach an agreement with Randall, then what price is Gretchen willing to pay the lawyer?

less than $220

Refer to the figure. The ____________ externalities in this market are evident because the private value is ____________.

positive; less than the social value of the good Positive externalities exist when the private value of the good is less than the social value of the good. Market participants do not account for the benefits to society.

Tradable pollution permits

set the quantity of pollution.

A corrective tax on pollution

sets the price of pollution.

To internalize a positive externality, an appropriate public policy response would be to

subsidize the good.

Environmental Protection Agency (EPA)

The US government agency tasked with developing and enforcing regulations aimed at protecting the environment

Suppose citizens living around Metropolitan Airport value peace and quiet at a value of $3 billion. Suppose there are no transaction costs and suppose that people have the right to peace and quiet. If it costs the airlines $2 billion to make their planes quieter, what is the private solution to the problem?

The airlines could spend $2 billion and make their planes quieter or buy the right to make noise for $3 billion, so they will choose to make the planes quieter for $2 billion.

When the government levies a tax on a good equal to the external cost associated with the good's production, it ________ the price paid by consumers and makes the market outcome ________ efficient.

increases; more

In Singapore, littering fines are strictly enforced. This is an example of a policy that

relies on incentives to reduce the pollution externality.

For the purpose of protecting the environment, upon which of the following approaches do we rely more and more as time goes by?

the requirement that decision makers bear the full costs of their actions

According to the Coase theorem, private parties can solve the problem of externalities if

there are no transaction costs.

The government engages in an industrial policy

to internalize the positive externality associated with technology-enhancing industries.

The Coase theorem does NOT apply if

transaction costs make negotiating difficult.

Refer to the Figure. What is the equilibrium price in this market?

$12 The equilibrium price is the price at which the supply and demand curves intersect.

Refer to the Figure. This graph represents the oil industry. The socially optimal price and quantity are

$16 and 500 units, respectively. The socially optimal price and quantity occur at the intersection of the demand curve and social cost curve.

Refer to the Figure. This graph shows the market for pollution permits. What corrective tax would achieve the same quantity of pollution as the pollution permit market?

$200 A pollution tax of $200 would achieve the same quantity of pollution (Q = 50) as the pollution permit market.

The government auctions off 500 units of pollution rights. They sell for $50 per unit, raising total revenue of $25,000. This policy is equivalent to a corrective tax of _____ per unit of pollution.

$50

Which of the following statements is not correct? A corrective tax encourages firms to further reduce pollution whereas a regulation provides no incentive to reduce pollution below the target. A corrective tax is less efficient than a regulation. Both regulation and corrective taxes can reduce pollution. An ideal corrective tax would equal the external cost from an activity with negative externalities.

A corrective tax is less efficient than a regulation. Economists usually prefer corrective taxes to regulations as a way to deal with pollution because corrective taxes can reduce pollution at a lower cost to society.

T/F The majority of economists do not like the idea of putting a price on polluting the environment.

FALSE economists generally think that a market for pollution will reduce pollution most efficiently.

T/F To reduce pollution by some targeted amount, it is most efficient if each firm that pollutes reduces its pollution by an equal amount.

FALSE firms that can reduce pollution at a lower cost should reduce their pollution more than firms that can reduce pollution at a greater cost.

T/F According to the Coase theorem, an externality always requires government intervention in order to internalize the externality.

FALSE the Coase theorem suggests that private parties can solve the problem of an externality on their own if there are no transaction costs.

T/F A market that generates a negative externality that has not been internalized generates an equilibrium quantity that is less than the optimal quantity.

FALSE the equilibrium quantity is greater than the optimal quantity.

T/F If Bob values smoking in a restaurant at $10 and Sue values clean air while she eats at $15, according to the Coase theorem, Bob will not smoke in the restaurant only if Sue owns the right to clean air.

FALSE the original distribution of property rights to the air will not affect the efficient solution.

Suppose the government imposes a tax in a certain market in order to internalize an externality. This type of policy is based on which of the Ten Principles of Economics?

People respond to incentives.

T/F When Smokey the Bear says, "Only you can prevent forest fires," society is attempting to use moral codes and social sanctions to internalize the externality associated with using fire while camping.

TRUE

T/F The Coase theorem may not result in an efficient solution in the presence of transaction costs and/or when there are many affected parties.

TRUE In the real world, sometimes bargaining does not work. Transaction costs, parties who hold out for a better deal, and coordinating the actions of a large number of people are examples when bargaining may not work.

T/F Research into new technologies creates positive externalities.

TRUE New technologies benefit not only the producing firm but also society as a whole because the new technology will enter society's pool of technological knowledge. This type of positive externality is called a technology spillover

Which of the following is not considered a transaction cost incurred by parties in the process of contracting to eliminate a pollution externality?

costs incurred to reduce the pollution

A positive externality (that has not been internalized) causes the

optimal quantity to exceed the equilibrium quantity.

A corrective tax

places a price on the right to pollute.

To internalize a negative externality, an appropriate public policy response would be to

tax the good.

Which of the following is not an example of a private solution to the problem of externalities? private contracts between parties with mutual interests the Coase theorem moral codes and social sanctions taxes

taxes Taxes are a public solution to the problem of externalities.

The most efficient pollution control system would ensure that

the polluters with the lowest cost of reducing pollution reduce their pollution the greatest amount.

If a car thief encounters a car with the Club and a car without it, the car with the Club imposes a (?) externality on the car without the Club. A policy implication of this result is a (?) those who use the Club.

negative; tax on The Club conveys a negative externality on other car owners because car thieves will not attempt to steal a car with the Club visibly in place, so they move on to another car. A policy implication is a tax on those who use the Club

Suppose a political candidate criticizes a government pollution permit policy that she says lets corporations buy and sell the right to pollute. She argues that our right to breathe and the future of our planet require real regulation instead of this type of government policy. Which of the following describes why most economists would disagree with her statement? -A free market in tradable pollution permits is typically more efficient than government regulation. -Clean air is a fundamental right, and government regulation will allow too much pollution. -A corrective tax would result in a more efficient outcome than either tradable permits or government regulation would. -The environment is so important that it should be protected as much as possible, regardless of the cost.

A free market in tradable pollution permits is typically more efficient than government regulation. The candidate's argument conflicts with standard economic thought because tradable pollution permits are a market-based policy that efficiently allocate the right to pollute. While government regulation of pollution can result in the same amount of pollution as a tradable pollution permit policy, it seldom results in an efficient allocation of the right to pollute among the regulated entities. A free market in tradable pollution permits achieves this goal by rewarding firms that are best at limiting pollution and by encouraging all firms to come up with cheaper ways to reduce pollution. While it is clearly desirable to breathe cleaner air, zero pollution is likely not an economically efficient outcome because its costs outweigh the benefits.

The government orders every factory to adopt a new technology, which reduces carbon-dioxide emissions into the atmosphere.

Command-and-Control Policy A command-and-control policy, or regulation, remedies an externality by legally limiting a specific behavior by a specific entity. Some examples of command-and-control policies are directly limiting the emissions of carbon dioxide by each factory or mandating that firms adopt emissions-reducing technology.

What are the two types of public policies toward externalities? Describe them. Which one do economists prefer? Why?

Command-and-control policies are regulations that prohibit certain behaviors. Market-based policies align private incentives with social efficiency. Economists prefer market-based policies because they are more efficient and they provide incentives for even further reduction in, say, pollution through advances in technology.

Trees take carbon dioxide out of the air and convert it to oxygen, so the government funds a tree-planting initiative by offering $480 to any citizen who plants a tree.

Corrective Subsidy A corrective subsidy encourages behavior that has positive external effects. Since planting trees generates a social value beyond the private value to the tree planter, a corrective subsidy to induce citizens to plant trees can help achieve the efficient quantity.

The government charges factories $480 for every ton of carbon dioxide they emit.

Corrective Tax A corrective tax, also known as a Pigovian tax, discourages behavior that has negative external effects. For example, since carbon-dioxide pollution generates a social cost beyond the private costs to the factory owner, a corrective tax can help achieve the socially optimal quantity of pollution.

Which of the following is true regarding tradable pollution permits and corrective taxes?

Corrective taxes and tradable pollution permits create an efficient market for pollution.

Which of the following statements is not correct? a. Both corrective taxes and tradable pollution permits provide market-based incentives for firms to reduce pollution. b. Corrective taxes set the maximum quantity of pollution, whereas tradable pollution permits fix the price of pollution. c. Tradable pollution permits have an advantage over corrective taxes if the government is uncertain as to the optimal size of the tax necessary to reduce pollution to a specific level. d. Both corrective taxes and tradable pollution permits reduce the cost of environmental protection and thus should increase the public's demand for a clean environment.

Corrective taxes set the maximum quantity of pollution, whereas tradable pollution permits fix the price of pollution.

You are home for semester break. Your father opens the mail. One of the letters is your parents' property tax bill. On the property tax bill, there is a deduction if the property owner has done anything to beautify his property. The property owner can deduct 50 percent of any expenditure on things such as landscaping from his property taxes. For example, if your parents spent $2,000 on landscaping, they can reduce their tax bill by 0.50*$2,000=$1,000 so that the true cost of the landscaping was only $1,000. Your father announces, "This is an outrage. If someone wants to improve his house, it is no one's business but his own. I remember some of my college economics, and I know that taxes and subsidies are always inefficient." What is the city government trying to subsidize with this tax break?

Expenditures on home improvement.

T/F If it costs Firm A $1,000 to reduce pollution by 10 units, yet it costs Firm B $800 to reduce pollution by 10 units, then a corrective tax will affect both firms equally.

FALSE Corrective taxes allocate pollution to the producers who face the highest cost of reducing pollution

T/F Private solutions produce efficient solutions to the problem of externalities, whereas public solutions do not.

FALSE Private solutions may produce efficient solutions, but not always. Transaction costs, parties who hold out for a better deal, and coordinating the actions of a large number of people may derail bargaining. Some public solutions produce efficient solutions. For example, a corrective tax in the presence of a negative externality leads to the socially optimal solution.

T/F A positive externality is an external benefit that accrues to the buyers in a market while a negative externality is an external cost that accrues to the sellers in a market.

FALSE a positive externality is a benefit that accrues to a bystander, and a negative externality is a cost that accrues to a bystander.

T/F A tax always makes a market less efficient.

FALSE corrective taxes can make a market more efficient.

Which of the following is an example of a positive externality? Dev mows Hillary's lawn and is paid $100 for performing the service. While mowing the lawn, Dev's lawnmower spews out smoke that Hillary's neighbor Kristen has to breathe. Hillary's newly cut lawn makes her neighborhood more attractive. Hillary's neighbors pay her if she promises to get her lawn cut on a regular basis.

Hillary's newly cut lawn makes her neighborhood more attractive

Does a corrective tax reduce or increase efficiency? Why?

It increases efficiency by shifting the supply or demand curve toward the true social cost or value curve, thereby making the market solution equal to the optimal or efficient solution.

Bob and Tom live in a university dorm. Bob values playing loud music at a value of $100. Tom values peace and quiet at a value of $150. Which of the following statements is true?

It is efficient for Bob to stop playing loud music regardless of who has the property right to the level of sound.

What are some types of private solutions to externalities?

Moral codes and social sanctions, charities, mergers between affected firms, contracts between affected firms.

Suppose that a commercial apple orchard uses pesticides in the production of apples. In the process, dangerous fumes drift across a nearby neighborhood. Is this an example of a positive or a negative externality? Explain.

Negative externality, because the social cost of producing apples exceeds the private cost of producing apples.

Suppose an individual enjoys lawn care and gardening a great deal. He uses pesticides to control insects and the harmful residue drifts across the neighborhood. He values the use of the pesticides at $10,000, and the neighborhood values clean air at $15,000. What does the Coase theorem suggest will take place?

No pesticides will be used, and the air will be clean, regardless of whether the individual owns the right to use pesticides or the neighborhood residents own the right to clean air. Either the individual will fail to buy the right to pollute or the neighborhood residents will pay the individual not to pollute.

Suppose citizens living around Metropolitan Airport value peace and quiet at a value of $3 billion. If it costs the airlines $4 billion to make their planes quieter (the airlines value noise at $4 billion), is it efficient for the government to require that the planes be muffled? Why or why not?

No, because the cost of correcting the externality exceeds the value placed on it by the affected parties.

Suppose citizens living around Metropolitan Airport value peace and quiet at a value of $3 billion. Suppose it costs the airlines $2 billion to make their planes quieter. If a private solution to the noise problem requires an additional $2 billion of transaction costs (due to legal fees, the large number of affected parties, and enforcement costs), can there be a private solution to the problem? Why or why not?

No, because the transaction costs exceed the potential gains from trade. (The potential gains are the $3 billion value of quiet minus the $2 billion cost to quiet the planes, or $1 billion.)

You are home for semester break. Your father opens the mail. One of the letters is your parents' property tax bill. On the property tax bill, there is a deduction if the property owner has done anything to beautify his property. The property owner can deduct 50 percent of any expenditure on things such as landscaping from his property taxes. For example, if your parents spent $2,000 on landscaping, they can reduce their tax bill by 0.50*$2,000=$1,000 so that the true cost of the landscaping was only $1,000. Your father announces, "This is an outrage. If someone wants to improve his house, it is no one's business but his own. I remember some of my college economics, and I know that taxes and subsidies are always inefficient." Although taxes and subsidies usually create inefficiencies, are taxes and subsidies always inefficient? Why or why not?

No. Appropriate corrective taxes and subsidies move a market closer to efficiency because the market equilibrium is inefficient to begin with.

Suppose that a commercial apple orchard uses pesticides in the production of apples. In the process, dangerous fumes drift across a nearby neighborhood. If this externality is not internalized, does the market overproduce or underproduce apples? What does it mean to overproduce or underproduce a product?

Overproduce. To overproduce is to produce units where the true cost exceeds the true value. To underproduce is to fail to produce units where the true value exceeds the true cost.

T/F An advantage of using tradable pollution permits to reduce pollution is that the regulator need not know anything about the demand for pollution rights.

TRUE

T/F For any given demand curve for pollution, a regulator can achieve the same level of pollution with either a corrective tax or by allocating tradable pollution permits.

TRUE

T/F If a market generates a negative externality, a corrective tax will move the market toward a more efficient outcome.

TRUE

T/F If a market generates a negative externality, the social cost curve is above the supply curve (private cost curve).

TRUE

T/F If a market generates a positive externality, the social value curve is above the demand curve (private value curve).

TRUE

T/F If transaction costs exceed the potential gains from an agreement between affected parties to an externality, there will be no private solution to the externality.

TRUE

Suppose that a commercial apple orchard uses pesticides in the production of apples. In the process, dangerous fumes drift across a nearby neighborhood. To internalize this externality, should the government tax or subsidize apples? Why or why not?

Tax apples because to internalize this externality, it requires that the supply curve for apples be shifted upward until it equals the true social cost curve.

Suppose citizens living around Metropolitan Airport value peace and quiet at a value of $3 billion. Suppose there are no transaction costs and suppose that airlines have the right to make as much noise as they please. If it costs the airlines $2 billion to make their planes quieter, what is the private solution to the problem?

The affected citizens must pay at least $2 billion and are willing to pay up to $3 billion to the airlines to have the planes made quieter.

Why are tradable pollution permits considered superior to corrective taxes at reducing pollution?

The regulator doesn't need to know anything about the demand to pollute in order to arrive at the targeted amount of pollution.

Which of the following statements about corrective taxes is generally NOT true? Economists prefer them to command-and-control regulation. They raise government revenue. They cause deadweight losses. They reduce the quantity sold in a market.

They cause deadweight losses

Bob and Tom live in a university dorm. Bob values playing loud music at a value of $100. Tom values peace and quiet at a value of $150. Which of the following statements is true about an efficient solution to this externality problem if Bob has the right to play loud music and if there are no transaction costs?

Tom will pay Bob between $100 and $150, and Bob will stop playing loud music.

The government limits total carbon-dioxide emissions by all factories to 130,000 tons per decade. Each individual factory is given the right to emit 170 tons of carbon dioxide, and factories may buy and sell these rights in a marketplace.

Tradable Permit System A tradable permit system remedies an externality by regulating general behavior—in this case, total emissions of carbon dioxide—but also by allowing market forces to determine individual outcomes—in this case, the amount that each individual factory pollutes.

Suppose that the government decides to issue tradable permits for a certain form of pollution. True or False: If the government chooses to distribute the permits, the allocation of permits among firms does not matter for efficiency, but it would affect the distribution of wealth.

True If the government allocates the permits to firms that do not value them as highly as other firms, the firms could sell the permits to each other so they would end up in the hands of the firms who value them most highly. Thus, the allocation of permits among firms would not matter for efficiency, but it would affect the distribution of wealth, because those that got the permits and sold them would be better off.

Suppose that the government decides to issue tradable permits for a certain form of pollution. True or False: In terms of economic efficiency in the market for pollution, it does not matter whether the government distributes the permits or auctions them off.

True In terms of economic efficiency in the market for pollution, it does not matter if the government distributes the permits or auctions them off, as long as firms can sell the permits to each other. The only difference would be that the government could make money if it auctioned the permits off, thus allowing it to reduce taxes, which would help reduce the deadweight loss from taxation in other markets. Some deadweight loss could also occur if firms use resources to lobby for additional permits.

You are home for semester break. Your father opens the mail. One of the letters is your parents' property tax bill. On the property tax bill, there is a deduction if the property owner has done anything to beautify his property. The property owner can deduct 50 percent of any expenditure on things such as landscaping from his property taxes. For example, if your parents spent $2,000 on landscaping, they can reduce their tax bill by 0.50*$2,000=$1,000 so that the true cost of the landscaping was only $1,000. Your father announces, "This is an outrage. If someone wants to improve his house, it is no one's business but his own. I remember some of my college economics, and I know that taxes and subsidies are always inefficient." What is the externality that this subsidy is trying to internalize?

When a house is well maintained, it raises the value (or fails to reduce the value) of the nearby property. Individual buyers and sellers in the market for home repair do not consider this when choosing the quantity of home repair, and thus, the optimal quantity exceeds the equilibrium quantity.

A positive externality generates

a social value curve that is above the demand curve (private value curve) for a good.

If a car thief encounters two cars without the Club, but the car thief fears a Lojack system might be installed in one of the cars, the car with the Lojack system imposes a (?) externality on the other car. A policy implication of this result is a (?) those who use the Lojack technology.

positive; subsidy for The Lojack system conveys a positive externality because thieves do not know which cars have this technology. Therefore, thieves are less likely to steal any car for fear that this technology is in place. A policy implication is a subsidy for car owners who use the Lojack technology.

Suppose an industry emits a negative externality such as pollution, and the possible methods to internalize the externality are command-and-control policies, corrective taxes, and tradable pollution permits. If economists were to rank these methods for internalizing a negative externality based on efficiency, ease of implementation, and the incentive for the industry to further reduce pollution in the future, they would likely rank them in the following order (from most favored to least favored):

tradable pollution permits, corrective taxes, command-and-control policies.

Josiah installed a metal sculpture in his front yard. A positive externality arises if the sculpture

​increases the value of other properties in the neighborhood.