Microeconomics - Chapter 7 & 10

What command-and-control policy might the landlord impose? A rental subsidy for those tenants who do not own any musical devices Correct A rule that music could not be played above a certain decibel level A tax on rent for those tenants who own speakers

A command-and-control policy is a government policy that requires or forbids certain behaviors. In this case, the landlord could impose a rule that music could not be played above a certain decibel level. This could be inefficient because there would be no harm done by Ringo playing his music loudly if Luciano is not home. See Section: Command-and-Control Policies: Regulation.

The demand curve for cookies is downward sloping. When the price of cookies is $2, the quantity demanded is 100. If the price rises to $3, what happens to consumer surplus? A. It falls by less than $100. B. It falls by more than $100 C. It rises by less than $100. D. It rises by more than $100.

A. It falls by less than $100. Because the demand curve reflects buyers' willingness to pay, the area below the demand curve and above the price measures the consumer surplus in a market. If the price of cookies rises by $1, you might be tempted to say that consumer surplus falls by $1 per cookie x $100 cookies=$100 However, demand is downward sloping, so an increase in price means a decrease in the quantity demanded. Therefore, consumer surplus must fall by less than $100. The following graph shows the loss in consumer surplus (CS) due to a price (P) increase. Notice that this area must be less than $100.

Jen values her time at $60 an hour. She spends 2 hours giving Colleen a massage. Colleen was willing to pay as much at $300 for the massage, but they negotiate a price of $200. A. consumer surplus is $20 larger than producer surplus. B. consumer surplus is $40 larger than producer surplus. C. producer surplus is $20 larger than consumer surplus. D. producer surplus is $40 larger than consumer surplus.

A. consumer surplus is $20 larger than producer surplus. (Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. In this case, Colleen was willing to pay $300 for a massage but it cost her only $200, so consumer surplus is 300=200=100 Producer surplus is the amount a seller is paid minus the cost of production. In this case, Jen's cost of production is 2 hours x $60 per hour = $120 and she gets paid $200, so producer surplus is $200-$120=$80 Therefore, consumer surplus is $20 larger than producer surplus. See Sections: Willingness to Pay; and Cost and the Willingness to Sell.)

If the external benefit is $10 per extinguisher, which of the following government policies would yield the efficient outcome? Check all that apply. A. Give out fire extinguishers for free. B. Subsidize people $10 for every fire extinguisher they buy. C. Tax people $10 for every fire extinguisher they buy. D. Mandate that every household has three fire extinguishers.

B. Subsidize people $10 for every fire extinguisher they buy. The government can correct the market failure by inducing market participants to internalize the externality. The appropriate response in the case of positive externalities is to subsidize consumers in order to entice them to purchase more of the good. In this case, a subsidy of $10 per fire extinguisher would yield the efficient outcome given the external benefit of $10 per fire extinguisher. See Section: Positive Externalities.

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

C. Hillary's newly cut lawn makes her neighborhood more attractive. (A positive externality arises when a person engages in an activity that influences the well-being of a bystander in a beneficial way but that person neither pays nor receives any compensation for that effect. In this case, Hillary having her lawn mowed positively benefits her neighbors by beautifying the neighborhood. See Section: Positive Externalities.)

An efficient allocation of resources maximizes A. consumer surplus. B. producer surplus. C. consumer surplus plus producer surplus. D. consumer surplus minus producer surplus.

C. consumer surplus plus producer surplus. If an allocation of resources maximizes total surplus, we say that the allocation exhibits efficiency. If an allocation is not efficient, then some of the potential gains from trade among buyers and sellers are not being realized. For example, an allocation is inefficient if a good is not being produced by the sellers with lowest cost. In this case, moving production from a high-cost producer to a low-cost producer will lower the total cost to sellers and raise total surplus. Similarly, an allocation is inefficient if a good is not being consumed by the buyers who value it most highly. In this case, moving consumption of the good from a buyer with a low valuation to a buyer with a high valuation will raise total surplus. See Section: The Benevolent Social Planner.

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

When the government levies a corrective tax in the presence of a negative externality, it increases the price paid by consumers, reduces the quantity sold in a market, and raises government revenue. Although many kinds of taxes distort the market and cause deadweight losses, corrective taxes alter incentives that market participants face to account for the presence of externalities and, thereby, move the allocation of resources closer to the social optimum, which reduces the deadweight loss already present with the negative externality. Additionally, economists usually prefer corrective taxes to regulations as a way to deal with pollution because they can reduce pollution at a lower cost to society. See Section: Market-Based Policy 1: Corrective Taxes and Subsidies.

Suppose the landlord lets the tenants do whatever they want. According to the Coase theorem, which of the following are true about Ringo and Luciano reaching an efficient outcome on their own? Check all that apply. Correct They might not be able to reach an agreement if the transaction costs are high. Ringo and Luciano can never reach an agreement without a third party assisting in the negotiations. Correct Ringo and Luciano may negotiate an agreement if bargaining is successful and neither holds out for a better deal.

According to the Coase theorem, if private parties can bargain over the allocation of resources at no cost, then the private market will always solve the problem of externalities and allocate resources efficiently. In this case, Ringo and Luciano could negotiate an agreement that might, for example, allow Ringo to play his music loudly at certain times of the day. They might not be able to reach an agreement if the transaction costs are high or if bargaining fails because each holds out for a better deal. See Section: The Coase Theorem.

The Coase theorem does not apply if A. there is a significant externality between two parties. B. the court system vigorously enforces all contracts. C. Correct transaction costs make negotiating difficult. D. both parties understand the externality fully.

According to the Coase theorem, if private parties can bargain over the allocation of resources at no cost, then the private market will always solve the problem of externalities and allocate resources efficiently. Therefore, the Coase theorem does not apply if transaction costs make negotiating difficult. See Section: The Coase Theorem.

The many identical residents of Whoville love drinking Zlurp. Each resident has the following willingness to pay for the tasty refreshment:

At a price of $1.50, each Whovillian will consume 4 bottles of Zlurp. Consumption beyond that point yields a marginal benefit ($1) that's less than the price ($1.50). Consumer surplus is the difference between a buyer's willingness to pay (what the item is worth to the buyer) and the price the buyer actually pays. Each consumer's total willingness to pay for 4 bottles is , and the total spent by each Whovillian on Zlurp is . Therefore, each consumer receives in consumer surplus.

John has been working as a tutor for $300 a semester. When the university raises the price it pays tutors to $400, Emily enters the market and begins tutoring as well. How much does producer surplus rise as a result of this price increase? A. by less than $100 B. between $100 and $200 C. between $200 and $300 D. by more than $300

B. between $100 and $200 When the price of tutoring services rises from $300 to $400, producer surplus rises. This increase in producer surplus has two parts: 1. John now receives $400-$300+$100 more for the tutoring services he was already providing. 2.Emily enters the market and receives a producer surplus somewhere between $0 and $100. Emily's producer surplus cannot be higher than $100 because if it were, then she would've provided tutoring services when the price was only $300. Therefore, overall producer surplus must rise between $100 and $200 when the price rises from $300 to $400. See Section: How a Higher Price Raises Producer Surplus.

When a market is in equilibrium, the buyers are those with the ________ willingness to pay, and the sellers are those with the ________ costs. A. highest, highest B. highest, lowest C. lowest, highest D. lowest, lowest

B. highest, lowest The price in a free market determines which buyers and sellers participate in a market. In particular, free markets allocate the supply of goods to the buyers who value them most highly, and they allocate the demand for goods to the sellers who can produce them at the lowest cost. See Section: Evaluating the Market Equilibrium.

Greater consumption of alcohol leads to more motor vehicle accidents and, thus, imposes costs on people who do not drink and drive.

Because alcohol consumption exhibits a negative externality, the supply curve does not reflect the cost to society of the good. Therefore, the social-cost curve lies above the supply curve, and the social-value curve is equal to the demand curve. See Section: Negative Externalities. The market equilibrium level of output occurs where quantity demanded equals quantity supplied, or where the demand and supply curves intersect. However, the efficient level of output occurs where the social-value curve (which is demand in this case) and the social-cost curve intersect. Therefore, the socially optimal quantity is less than the quantity that the private market would naturally reach on its own. The triangular area between the demand and social-cost curve from the optimal quantity and market equilibrium quantity represents the deadweight loss in this case. This area shows the amount by which social costs exceed social value for the quantity of alcohol consumption beyond the efficient level. See Section: Negative Externalities.

Fire extinguishers exhibit positive externalities because, even though people buy them for their own use, they may prevent fire from damaging the property of others. The following graph shows the market for fire extinguishers. Determine whether the private and social values are equal in this case. If they are not, shift the demand curve in the appropriate direction to reflect this difference. Then determine whether the private and social costs are equal in this case. Again, if they are not, shift the supply curve to reflect this difference.

Because fire extinguishers exhibit a positive externality, the demand curve does not reflect the value to society of the good. Therefore, the social-value curve lies above the demand curve, and the social-cost curve is equal to the supply curve. See Section: Positive Externalities. The market equilibrium level of output occurs where quantity demanded equals quantity supplied, or where the demand and supply curves intersect. However, the efficient level of output occurs where the social-value curve and the social-cost curve (which is supply in this case) intersect. Therefore, the socially optimal quantity is greater than the quantity that the private market would naturally reach on its own. See Section: Positive Externalities.

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. A. above, greater B. Correct above, less C. below, greater D. below, less

Because of the externality, the cost to society of producing the good is larger than the cost to the producers of that good. Therefore, the social-cost curve is above the supply curve because it takes into account the external costs imposed on society by the production of the good. This causes the equilibrium quantity to be larger than the socially optimal quantity because the market equilibrium reflects only the private costs of production. See Section: Negative Externalities.

Based on your calculations, you would Correct support the mayor's policy because it increases Correct welfare compared to before the tax.

Because per-person total surplus is higher with the tax ($4.50) than without it ($4.00), you would support the mayor's policy. See Section: Negative Externalities.

TRAFFIC A local drama company proposes a new neighborhood theater in San Francisco. Before approving the building permit, the city planner completes a study of the theater's potential impact on the surrounding community. One finding of the study is that theaters attract traffic, which adversely affects the community. The city planner estimates that the cost to the community from the extra traffic is $5 per theater ticket. This is negative Correct externality because the social cost Correct is greater than the private cost Correct .

Because the presence of a new neighborhood theater causes additional traffic congestion, the social cost of theater tickets is greater than the private cost in this case. Therefore, this represents a negative externality. See Section: Negative Externalities.

he following graph shows the demand and supply for theater tickets in this neighborhood.

Because there is no external benefit, the social-value curve is the same as the demand curve in this case. However, the social-cost curve lies $5 above the supply curve at each quantity because this is the amount of the external cost as a result of the theater. The market equilibrium level of output occurs where quantity demanded equals quantity supplied, or where the demand and supply curves intersect; this occurs at a quantity of 50 tickets and a price of $5.00 per ticket. However, the efficient level of output occurs where the social-value curve (which is demand in this case) and the social-cost curve intersect; this occurs at a quantity of 25 tickets and a price of $7.50 per ticket. Therefore, the socially optimal quantity is less than the quantity that the private market would naturally reach on its own. See Section: Negative Externalities.

Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer's willingness to pay is A. negative. B. zero. C. positive but less than the marginal seller's D. positive and greater than the marginal seller's cost.

C. positive but less than the marginal seller's Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus. Producing a quantity larger than the equilibrium quantity results in the value to the marginal buyer being less than the cost to the marginal seller. In this case, decreasing the quantity raises total surplus, and this continues to be true until quantity falls to the equilibrium level. See Section: Evaluating the Market Equilibrium.

Why are command-and-control approaches generally unable to target the firms that should undertake bigger reductions? Check all that apply. The costs of reducing pollution are the same across firms. CORRECT - Command-and-control approaches often rely on uniform reductions among firms. CORRECT - There is no incentive to reduce pollution beyond the mandated amount.

Command-and-control approaches that rely on uniform pollution reduction among firms give the firms no incentive to reduce pollution beyond the mandated amount. Instead, every firm will reduce pollution by just the amount required and no more. See Section: Command-and-Control Policies: Regulation.

Cindy Lou Who, one of the residents of Whoville, decides on her own to reduce her consumption of Zlurp by 1 bottle. Cindy's consumer surplus (ignoring the cost of pollution she experiences) is now $7.50. Her decision increases Correct total surplus in Whoville by $0.50.

Consumer surplus is the difference between a buyer's willingness to pay (what the item is worth to the buyer) and the price the buyer actually pays. If Cindy Lou Who consumes only 3 bottles, her total willingness to pay is 5+4+3=12 , and she spends 1.50 per bottle x3 bottles = 4.50. This yields a consumer surplus (CS) $12.00-$4.00= 7.50 of without accounting for the negative externality. Because each bottle has an external cost of $1, Cindy Lou Who's consumption reduction decreases the external cost experienced by $1.00, thus increasing total surplus (TS): Change in Total Surplus = Increase in TS Caused by Decreased Externality+Change in Cindy Lou's CS = 1.00-0.50 = 0.50 Therefore, total surplus in Whoville increases by $1.00-.050=0.50 . See Section: Negative Externalities.

Economists argue that appropriate corrective taxes or tradable pollution rights will result in efficient pollution reduction. Which of the following statements supports this claim? Check all that apply. CORRECT- The government does not have to figure out which firms can reduce pollution the most. CORRECT - Corrective taxes or tradable pollution rights give firms greater incentives to reduce pollution. With corrective taxes or tradable pollution rights, firms spend less in research on pollution control.

Corrective taxes or tradable pollution rights give firms greater incentives to reduce pollution. Firms are rewarded by paying lower taxes or spending less on permits if they find methods to reduce pollution, so they have the incentive to engage in research on pollution control. The government does not have to figure out which firms can reduce pollution the most—it lets the market give firms the incentive to reduce pollution on their own. See Sections: Market-Based Policy 1: Corrective Taxes and Subsidies; and Market-Based Policy 2: Tradable Pollution Permits.

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. A. $10 B. Correct $50 C. $450 D. $500

In the case of a corrective tax, the supply curve for pollution rights is perfectly elastic because firms can pollute as much as they want by paying the tax, and the position of the demand curve determines the quantity of pollution. In the case of pollution permits, the supply curve for pollution rights is perfectly inelastic because the quantity of pollution is fixed by the number of permits, and the position of the demand curve determines the price of pollution. Hence, the government can achieve a pollution level of 500 units by setting a corrective tax of $50 per unit or by auctioning off 500 permits. See Sections: Market-Based Policy 1: Corrective Taxes and Subsidies; and Market-Based Policy 2: Tradable Pollution Permits.

Many observers believe that the levels of pollution in our society are too high. If society wishes to reduce overall pollution by a certain amount, which of the following reasons supports why it's efficient to have different amounts of reduction at different firms? Check all that apply. CORRECT - The costs of reducing pollution differ across firms. All firms should be allowed to produce some pollution. Firms with the highest profit should bear the largest burden of reducing pollution. The costs of reducing pollution are the same across firms.

It is efficient to have different amounts of pollution reduction at different firms because the costs of reducing pollution differ across firms. If all firms were made to reduce pollution by the same amount, the costs would be low to some firms and prohibitive at others, imposing a greater burden overall. See Section: Command-and-Control Policies: Regulation.

Ringo loves playing rock 'n' roll music at high volume. Luciano loves opera and hates rock 'n' roll. Unfortunately, they are next-door neighbors in an apartment building with paper-thin walls. In this case, Ringo Correct imposes anegative Correct externality on his neighbor in the form of noise pollution.

Ringo's consumption of rock 'n' roll music affects Luciano, but Ringo does not consider that in deciding how loudly he plays his music. Therefore, Ringo imposes a negative externality on Luciano when he plays his music too loudly. See Section: Negative Externalities.

Mayor Grinch imposes a $1 tax on each bottle of Zlurp. Consumption per person is now 3bottles. This yields a per-person consumer surplus of $4.50 not including the cost of pollution, a per-person external cost of $3.00, and government revenue of $3.00 per person. Total surplus per person is now $4.50 as a result of this policy. (Hint: Total surplus is equal to consumer surplus minus the external cost of pollution plus government revenue.)

The $1 tax raises the price of a bottle of Zlurp to $2.50 because the entire tax will be borne by consumers given the perfectly elastic supply curve. At a price of $2.50, each Whovillian will consume 3 bottles of Zlurp. Consumer surplus is the difference between a buyer's willingness to pay (what the item is worth to the buyer) and the price the buyer actually pays. Each consumer's total willingness to pay for 3 bottles is , and the total spent by each Whovillian on Zlurp is . Therefore, each consumer receives in consumer surplus. Because each bottle has an external cost of $1, the per-person external cost is . Moreover, the government collects per person in revenue. Therefore, total surplus with the tax is equal to . See Section: Negative Externalities.

Consider two ways to protect your car from theft. The Club (a steering wheel lock) makes it difficult for a car thief to take your car. Lojack (a tracking system) makes it easier for the police to catch the car thief who has stolen it. 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. Negative - Correct Positive A policy implication from this result includes a ____ Correct those who use the Club. Tax on - Correct Subsidy for

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. This means that they will move on to another car. A policy implication includes a tax on those who use the Club. See Section: Negative Externalities.

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. Negative Positive - Correct A policy implication from this result includes a ____ for Correct those who use the Lojack technology. Tax on Subsidy for - Correct

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 includes a subsidy for car owners that use the Lojack technology. See Section: Positive Externalities.

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. A. Correct increases, more B. increases, less C. decreases, more D. decreases, less

When the government levies a corrective tax in the presence of a negative externality, it increases the price paid by consumers. Although many kinds of taxes distort the market in a negative way, corrective taxes alter incentives that market participants face to account for the presence of externalities and, thereby, move the allocation of resources closer to the social optimum. Thus, while corrective taxes raise revenue for the government, they also enhance economic efficiency. See Section: Market-Based Policy 1: Corrective Taxes and Subsidies.