Problem Set 8
A Pigovian tax is
a tax to bring about an efficient level of output in the presence of externalities.
When there are many people involved in attempting to reach an agreement, the transactions costs are often _______ than the net benefits from reducing an externality. In such cases, a private solution to an externality problem _______ feasible.
higher; is not
The public choice model
applies economic analysis to government decision making.
The Coase Theorem states that
if transaction costs are low, private bargaining will result in an efficient solution to the problem of externalities.
Barney subscribes to the NFL Sunday Ticket, a program package offered by DirecTV that allows Barney to watch every regular season NFL game played on Sundays. (Barney can watch Sunday Night Football without subscribing to the Sunday Ticket.) The subscription price for the Sunday Ticket is in addition to the fee paid for Barney's DirecTV package. Barney invites two friends who work with him to watch football on Sundays at his home. Considering that Barney can watch any football game broadcast on Sundays, including those games not shown on his local television stations, he is Barney's friends are
not a free rider because Barney pays for the program package; free riders because because they benefit from watching Sunday games without paying for them.
One result of the public choice model is that most economists believe that
policymakers may have incentives to intervene in the economy in ways that do not promote economic efficiency.
"It was important... to understand the ways that government could fail systematically." In this context, government failure means Public choice theory helps us to understand how government could fail systematically because it recognizes that policymakers are
politicans making bad decisions for their own selfish reasons; no different than consumers or managers of firms and are likely to pursue their own self-interest, even if their self-interest conflicts with the public interest.
An individual producer or a consumer "internalizes an externality" when
in their own decisions they take into account the external effects of their actions.
Examples of transaction costs include
the cost of monitoring an agreement, the time required to negotiate an agreement, the cost of drafting a contract or agreement.
At what level must a Pigovian tax be set to achieve efficiency? A Pigovian tax must be set equal to
the cost of the externality.
What are the sources of externalities and market failure?
the difficulty of enforcing property rights in certain countries & incomplete property rights
When a Pigouvian tax is imposed, ________.
the marginal private cost curve shifts upward
How is free riding related to the tendency of a public good to create market failure? Free riding results in
the market producing a quantity of public goods that is inefficiently low because they are nonexcludable.
One important difference between the political process and the market process is that
the political process results in collective actions in which everyone is obliged to participate while in the market process individuals are free to participate or not.
William Easterly in The White Man's Burden shares the following account by New York University Professor Leonard Wantchekon of how Professor Wantchekon's village in Benin, Africa, managed the local fishing pond when he was growing up: To open the fishing season, elders performed ritual tests at Amlé, a lake fifteen kilometers from the village. If the fish were large enough, fishing was allowed for two or three days. If they were too small, all fishing was forbidden, and anyone who secretly fished the lake at this time was outcast, excluded from the formal and informal groups that formed the village's social structure. Those who committed this breach of trust were often shunned by the whole community; no one would speak to the offender, or even acknowledge his existence for a year or more. The village elders were trying to prevent the economic problem of The solution of the village elders to outcast those who committed the breach of trust by fishing in the pond when it was forbidden is an example of
the tragedy of the commons; using community norms to solve the problem. The solution would most likely be effective because it was used in a small community.
"Rent-seeking is a very useful concept to have around when thinking about policy." Rent seeking is Rent seeking can be useful in understanding why government policies
lobbying or bribing politicians to gain favorable legislation or regulations; sometimes produce results that are inefficient and harmful to the people
Are policymakers susceptible to rent-seeking behavior? Explain. Rent-seeking behavior
may succeed when many voters are rationally ignorant
Your neighbor John has a barking dog. Which of the following statements is true?
It can create negative externalities by disrupting your sleep and can also create positive externalities by discouraging intruders.
Cable TV and Toll Roads
Quasi-public goods
Traffic congestion is an example of a ________.
negative externality
The presence of a positive externality in a market leads to ________.
underproduction of the good
Rent seeking is an attempt to
use the government for individual benefit at the expense of others. Regulatory capture is an example of this, where a regulatory agency makes decisions benefiting the firm being regulated.
Fish and public pasture
common resources
Which of the following best describes the process of regulatory capture? A. Bank of America encourages the FDIC-Federal Deposit Insurance Corporation- to make banks with less than $50 million of deposits pay a higher percentage into the insurance fund "for the protection of consumers." B. Michigan decides to lower its sales tax rate while increasing the income tax rate on incomes above $200,000. C. Major League Baseball spends money lobbying members of congress to keep its anti-trust exemption. D. An Alabama senator agrees to vote for a Kentucky senator's bridge project, in hopes that the Kentucky senator will vote for the Alabama senator's electric dam project.
A. Bank of America encourages the FDIC-Federal Deposit Insurance Corporation- to make banks with less than $50 million of deposits pay a higher percentage into the insurance fund "for the protection of consumers."
The public choice model raises questions about the government's ability to regulate economic activity efficiently. Which of the following statements represents the views of most economists with regard to the role of government?
Agencies such as the Food and Drug Administration and the Environmental Protection Agency can serve a useful purpose, but we need to take the costs of regulation into account along with the benefits.
Hiking in a large park (no congestion) surrounded by a fence:
A quasi-public good
The public choice model can be used to examine voting models that contrast the manner in which collective decisions are made by governments (state, local, and federal) and the manner in which individual choices are made in markets. Which of the following descriptions is consistent with the difference between collective decision−making and decision−making in markets? A. The cost of a government policy is determined by a majority vote of members of the public; decisions made in markets are based on individual willingness to pay. B. Individuals are less likely to see their preferences represented in the outcomes of government policies than in the outcomes of markets. C. Choices made through government policies are more important than decisions individuals make through markets. D. Everyone who votes must agree with a decision made collectively through government, but in markets individuals can make their own choices.
B. Individuals are less likely to see their preferences represented in the outcomes of government policies than in the outcomes of markets.
Which of the following is an example of rent seeking behavior? A. Amazon introduced the Kindle to compete with Sony's Digital Reader. Amazon was motivated by the desire to earn profits from the Kindle but also increased the choice of digital music players available to consumers. B. U.S. sugar firms convinced Congress to impose a quota on imports of sugar. C. Recent increases in cigarette taxes faced little opposition from voters, many of whom were rationally ignorant with respect to the tax. D. Apple earned large profits from the development and sale of the iPhone.
B. U.S. sugar firms convinced Congress to impose a quota on imports of sugar.
Which of the following is not an example of rent-seeking behavior? A. competition for the exclusive right to import a product B. engaging in aggressive advertising that slams a competitor's product C. lobbying the government to impose tariffs on certain imported products D. competition for subsidies
B. engaging in aggressive advertising that slams a competitor's product
Farmer Owens has an apple orchard that must be pollinated by bees in order to bear fruit. Farmer Owens's neighbor, Maude, owns beehives with bees that can pollinate the apple trees. Suppose the benefit of the bees to Farmer Owens is $1,000 per year. Suppose the bees provide no benefit to Maude but she must pay $3,000 per year to maintain the hives. If Farmer Owens and Maude engage in Coase bargaining, what would likely result?
Farmer Owens would not be willing to pay Maude an amount such that she would maintain the hives.
Jess practices her electronic keyboard every evening for an upcoming musical concert. The sound disturbs Felix, who usually works on his college assignments around the same time. The value of the practice to Jess is $100, while the cost of the practice to Felix is $80. According to George, a student of economics, Jess should pay Felix $80 to continue her practice for the musical concert. Which of the following assumptions is being made by George?
He assumes that Felix has the right to quiet studying conditions.
In a study of a large state university, students were randomly assigned roommates. Researchers found that, on average, males assigned to roommates who reported drinking alcohol in the year before entering college had GPAs one-quarter point lower than those assigned to non-drinking roommates. For males who drank frequently before college, being assigned to a roommate who also drank frequently before college reduced their GPAs by two-thirds of a point. The figure to the right shows the supply (or marginal private cost) of alcohol and the demand (or marginal private benefit) for alcohol. Use the line drawing tool to draw a curve showing the marginal social benefit of alcohol. Properly label this line.
MSB = new demand curve; demand curve (MPB) shifts less for negative externalities
What is the focus of a command-and-control approach to reducing pollution?
The government imposing quantitative limits on the amount of pollution firms are allowed to generate.
The advanced machinery used for limestone quarrying in a particular region leads to noise pollution and affects the hearing ability of people residing in the neighborhood. The quarrying activity also results in soil erosion. According to an environmental research group, the market price and output of limestone in this region is much higher than the socially efficient level, as the limestone producers do not include the social cost of production in their output decision. The group formally requests the government to impose a tax on limestone production to internalize the externality. Suppose the government responds by imposing a tax on the production of limestone. After the tax is imposed, total production of limestone declines by the amount the environmental research group had estimated. This convinces them that limestone production is now socially efficient. Which of the following conclusions can most reasonably be drawn from the given information?
The marginal private cost of producing limestone at this quarry is now equal to the marginal social cost as estimated by the research group.
Yellowstone National Park is in bear country. The National Park Service, at its Yellowstone Web site, states the following about camping and hiking in bear country: Do not leave packs containing food unattended, even for a few minutes. Allowing a bear to obtain human food even once often results in the bear becoming aggressive about obtaining such food in the future. Aggressive bears present a threat to human safety and eventually must be destroyed or removed from the park. Please obey the law and do not allow bears or other wildlife to obtain human food. What externality does obtaining human food pose for the bear? What externality does the bear's obtaining human food pose for future campers and hikers?
a negative externality for the bears because the taste of human food often causes the bears to be aggressive and since they pose a threat to human safety, they are eventually removed from the park or even destroyed; a negative externality for the future campers and hikers since they may be attacked by aggressive bears who are searching for more human food.
As readers of Herman Melville's 1851 novel Moby Dick know, at one time oil made from whale blubber was an important source of energy that was widely used by households and firms in oil lamps. Other sources of energy supplanted whale oil in the second half of the nineteenth century, and today many Americans consider whales only as a source of entertainment on visits to aquariums and whale watching excursions. But some species of whales—including baleen and gray whales—are in danger of extinction. The U.S. Department of Agriculture estimates that over 9 billion chickens are raised for food annually. Chickens, unlike whales, are not threatened with extinction because chickens
are privately owned and their owners have an incentive to ensure that they do not become extinct.
A corrective subsidy induces the ________ to the socially optimal level.
consumers of a positive externality to increase the quantity consumed
Jeff and James have different opinions regarding the amount the U.S. government should spend on national defense. Jeff believes that more should be spent in order to ensure that the country's enemies will not challenge the United States militarily. James believes that a lot of defense spending is wasted on overpriced military equipment and that the United States "should not be the world's policeman." Suppose that instead of the U.S. Congress and the president having the authority to determine the amount the military has to spend, this authority is turned over to the private sector. A privately owned firm conducts a survey to determine the willingness of people to pay for national defense. In response to the survey, both Jeff and James state that they are not willing to pay anything for national defense. If Jeff and James made this response they would
be free riders because they would still receive the same amount of protection as everyone else whether or not they pay.
Why is a typical person likely to gather more information when buying a new car than when voting for a member of Congress?
because buying a new car affects a person more immediately and personally compared to voting for a member of Congress. In the latter, a person's vote is only one of many voters and therefore, not likely to have a large impact on the outcome.
What is free riding?
benefiting from a good without paying for it.
The parties involved in an externality have an incentive to reach an efficient solution because
both parties become better off when an efficient solution is reached.
Education in a public school (Grades K through 12):
common resource
Every year at the beginning of flu season, many people, including the elderly, get a flu shot to reduce their chances of contracting the flu. One result is that people who do not get a flu shot are less likely to contract the flu. Getting a flu shot results in a
positive externality
An apple
private good
Education in a private school (Grades K through 12):
private good
Mail delivery
private good
Shoes and burgers
private goods
A television broadcast of the World Series:
public good
Hiking in a large park (no congestion) not surrounded by a fence:
public good
National defense and court system
public goods
A producer or a consumer will internalize an externality because
they have an incentive to consider the external effects of their actions due to taxes that are imposed or subsidies that they receive.
In the presence of a positive externality, the market equilibrium will produce __________ of the good.
too little
When are we likely to see private solutions to the problem of externalities?
when the parties involved have information about the externality, when transaction costs are low, when the number of parties involved is small.
