EOC16: End of Chapter Problems - Ch. 16: Externalities

According to a report from the U.S. Census Bureau, "the average [lifetime] earnings of a full-time, year-round worker with a high school education are about $1.2 million compared with $2.1 million for a college graduate." This indicates that there is a considerable benefit to a graduate from investing in his or her own education. Tuition at most state universities covers only about two-thirds to three-quarters of the cost, so the state applies a Pigouvian subsidy to college education. If a Pigouvian subsidy is appropriate, is the externality created by a college education a positive or a negative externality? What does this imply about the differences between the costs and benefits that accrue privately to students compared to social costs and benefits?

A college education generates positive externalities. The social benefit of having another college graduate in society exceeds the private benefit to the graduate.

To recline or not to recline? In early 2020, a passenger on an American Airlines flight was caught on video continuously punching the back of the seat in front of him, in which another passenger sat in the reclined position. The video went viral and sparked a national debate on whether passengers should recline their seats. Using the Coase theorem, recommend one remedy that can provide an efficient solution to this problem.

The airline can define who owns that space, and if transaction costs are low, people can trade. Whoever values it the most will end up with the right to use it.

Fishing for sablefish has been so intensive that sablefish were threatened with extinction. After several years of banning such fishing, the government is now proposing to introduce tradable vouchers, each of which entitles its holder to a catch of a certain size. How can uncontrolled fishing generate a negative externality, and how can the voucher scheme overcome the inefficiency created by this externality?

Uncontrolled fishing makes it harder for sablefish populations to recover from fishing, reducing fish stocks for next season. Limiting the total number of fish caught will allow the sablefish population to stabilize and ensure the size of future catches. It will also ensure that the most cost-effective fishing operations remain in operation over costlier operations.

The two dry-cleaning companies in Collegetown, College Cleaners, and Big Green Cleaners, are a major source of air pollution. Together, they currently produce 350 units of air pollution, which the town wants to reduce to 200 units. The accompanying table shows the current pollution level produced by each company and each company's marginal cost of reducing its pollution. The marginal cost is constant. CompaniesInitial pollutionlevel (units)Marginal cost ofreducing pollution(per unit)College Cleaners230$5Big Green Cleaners120$2 a. Suppose that Collegetown passes an environmental standards law that limits each company to 100 units of pollution. What would be the total cost to the two companies of each reducing its pollution emissions to 100 units? College Cleaners: $ _____________________ Big Green Cleaners: $ ______________ both companies: $_____________________ b. How much is each pollution voucher worth to College Cleaners? To Big Green Cleaners? (That is, how much would each company, at most, be willing to pay for one more voucher?) College Cleaners: $ _____________________ Big Green Cleaners: $ ______________ c. Who will sell vouchers, and who will buy them? How many vouchers will be traded? __________________________ will sell vouchers, and Number of vouchers traded _____________________ __________________________ will buy them. d. What is the total cost to the two companies of the pollution controls under this voucher system? Total cost under voucher system: $ ____________________________________

a. 650; 40; 690 b. 5; 2 c. Big Green Cleaners; College Cleaners; 100 d. 390

Voluntary environmental programs were extremely popular in the United States, Europe, and Japan in the 1990s. Part of their popularity stems from these programs not requiring legislative authority, which is often hard to obtain. The 33/50 program started by the Environmental Protection Agency (EPA) is an example of such a program. With this program, the EPA attempted to reduce industrial emissions of 17 toxic chemicals by providing information on relatively inexpensive methods of pollution control. Companies were asked to voluntarily commit to reducing emissions from their 1988 levels by 33% by 1992 and by 50% by 1995. The program actually met its second target by 1994. a. The accompanying graph depicts the marginal benefit curves (𝑀𝐵𝐴, 𝑀𝐵𝐵)MBA, MBB) for the pollution generated by two plants, A and B. Suppose the plants were participants in the 33/50 program. In the accompanying graph which depicts the marginal benefits for each plant, mark the targeted levels of pollution in 1995 for the two plants by moving points 𝑆𝐴(1995) and 𝑆𝐵(1995) Which plant was required to reduce emissions more? Was this solution necessarily efficient? b. What kind of environmental policy does the 33/50 program most closely resemble? What is the main shortcoming of such a policy?

a. Graph: S A point at half way point on MB A Line S b point at half way point on MB B Line Both plants reduced emissions by the same amount. This solution was not efficient; it would be more efficient if plant A reduced its emissions more than plant B. b. Environmental standard This policy does not permit firms to reduce pollution emissions in the most cost-effective way possible.

a. EAuction and EMarketplace are two competing internet auction sites, where buyers and sellers transact goods. Each auction site earns money by charging sellers for listing their goods. EAuction has decided to eliminate fees for the first transaction for sellers who are new to its site. Why is this likely to be a good strategy for EAuction in its competition with EMarketplace? b. EMarketplace complained to the Justice Department that EAuction's practice of eliminating fees for new sellers was anti-competitive and would lead to monopolization of the internet auction industry. Is EMarketplace correct? How should the Justice Department respond? c. EAuction stopped its practice of eliminating fees for new sellers. But since it provided much better technical service than its rival, EMarketplace, buyers and sellers came to prefer EAuction. Eventually, EMarketplace closed down, leaving EAuction as a monopolist. Should the Justice Department intervene to break EAuction into two companies? Explain. d. EAuction is now a monopolist in the internet auction industry. It also owns a site that handles payments over the internet, called PayForIt. It is competing with another internet payment site, called PayBuddy. EAuction has now stipulated that any transaction on its auction site must use PayForIt, rather than PayBuddy, for the payment. Should the Justice Department intervene? Explain.

a. Internet auction sites are characterized by network externalities. EAuction's fee elimination attracts first-time sellers to the site, generating network externalities for the other sellers who already sell their wares on EAuction. b. EMarketplace is correct. EAuction's fee elimination strategy is anti-competitive since it capitalizes on network externalities to attempt to create a monopoly. The Justice Department should require EAuction to reinstate fees for first-time sellers. c. The Justice Department should not break up EAuction. The internet auction market has become a natural monopoly due to network externalities. Since EAuction achieved monopoly status by offering superior service, it has done nothing illegal to earn its position, and the market is better served by a single auction site. d. The Justice Department should intervene. EAuction is using its market power in the internet auction industry to gain market power in another industry.

Voluntary environmental programs were extremely popular in the United States, Europe, and Japan in the 1990s. Part of their popularity stems from these programs not requiring legislative authority, which is often hard to obtain. The 33/50 program started by the Environmental Protection Agency (EPA) is an example of such a program. With this program, the EPA attempted to reduce industrial emissions of 17 toxic chemicals by providing information on relatively inexpensive methods of pollution control. Companies were asked to voluntarily commit to reducing emissions from their 1988 levels by 33% by 1992 and by 50% by 1995. The program actually met its second target by 1994. a. In the accompanying graph move the marginal benefit curves (𝑀𝐵𝐴, 𝑀𝐵𝐵)MBA, MBB) for the pollution generated by two plants, A and B, in 1988. Assume that without government intervention, each plant emits the same amount of pollution, but that at all levels of pollution less than this amount, plant A's marginal benefit of polluting is less than that of plant B. Mark the quantity of pollution that each plant produces without government action (𝑄𝑀𝐾𝑇)(QMKT). b. Do you expect the total quantity of pollution before the program was put in place to have been less than or more than the optimal quantity of pollution? Why?

a. MB A & MB Lines y-axis, 1 to the left from the right corner and QMKT point at intersection b. The total quantity of pollution before the program will be more than the optimal quantity of pollution. Pollution generates external costs that polluters do not incur, so they overpollute.

Many dairy farmers in California are adopting a new technology that allows them to produce their own electricity from methane gas captured from animal waste. (One cow can produce up to 2 kilowatts a day.) This practice reduces the amount of methane gas released into the atmosphere. In addition to reducing their own utility bills, the farmers are allowed to sell any electricity they produce at favorable rates. a. Explain how the ability to earn money from capturing and transforming methane gas behaves like a Pigouvian tax on methane gas pollution and can lead dairy farmers to emit the efficient amount of methane gas pollution. b. Suppose some dairy farmers have lower costs of transforming methane into electricity than others. Explain how this system of capturing and selling methane gas leads to an efficient allocation of emissions reduction among farmers.

a. The "tax" on methane gas pollution takes the form of an opportunity cost. If farmers can generate additional revenue by capturing methane gas, then releasing the gas into the atmosphere denies farmers that revenue. b. Farmers earn the same revenue from capturing methane but face different costs from doing so. Accordingly, farmers with low capture costs will reduce their methane emissions more than farmers with high capture costs.

Which of the following are characterized by network externalities? Which are not? Explain. a. The choice between installing 110-volt electrical current in structures rather than 220-volt b. The choice between purchasing a Toyota versus a Ford c. The choice of a printer, where each printer requires its own specific type of ink cartridge d. The choice of whether to purchase an iPad Air or an iPad Mini.

a. The choice is characterized by network externalities. Electricity voltage dictates what type of appliances and other electrical equipment can be used in your house. Using a voltage that is not widely adopted limits your choices of these items. b. The choice is not characterized by network externalities. A sufficiently robust market exists for both parts and service for these makes of vehicle, so you can expect to keep either vehicle in good repair. c. The choice is characterized by network externalities. The prevalence or scarcity of different printers affects the availability of ink cartridges. d. The choice is not characterized by network externalities. Each device can perform the same functions as the other and has the same suite of available apps.

The city of Falls Church, Virginia, subsidizes the planting of trees in homeowners' front yards when they are within 15 feet of the street. a. Using concepts in the chapter, explain why a municipality would subsidize planting trees on private property but near the street. b. In the accompanying graph, place the marginal social benefit (MSB), marginal social cost (MSC), and the optimal Pigouvian subsidy (point O) of planting trees.

a. Trees near the street generate positive externalities, so the municipality imposes a Pigouvian subsidy to encourage homeowners to plant the optimal level of trees. Without the subsidy, private homeowners would plant too few trees. b. MSB Line Cross Up Down from left to right MSC Cross reflected Point-O at Intersection

What type of externality (positive or negative) is present in each of the following examples? Is the marginal social benefit of the activity greater than or equal to the marginal benefit to the individual? Is the marginal social cost of the activity greater than or equal to the marginal cost to the individual? Without intervention, will there be too little or too much (relative to what would be socially optimal) of this activity? a. Mr. Chau plants lots of colorful flowers in his front yard. A ____________ externality is present in this example. The marginal social benefit of this activity is ___________ the marginal benefit to the individual. The marginal social cost of the activity is ____________________ the marginal cost to the individual. Without intervention, there will be _______________ of this activity. b. Your next-door neighbor likes to build bonfires in his backyard, and sparks often drift onto your house. A _________ externality is present in this example. The marginal social benefit of this activity is ____________ the marginal benefit to the individual. The marginal social cost of the activity is ________________ the marginal cost to the individual. Without intervention, there will be ____________ of this activity. c. Maija, who lives next to an apple orchard, decides to keep bees to produce honey. A ____________ externality is present in this example. The marginal social benefit of this activity is _____________ the marginal benefit to the individual. The marginal social cost of the activity is _______________ the marginal cost to the individual. Without intervention, there will be _____________ of this activity. d. Justine buys a large SUV that consumes a lot of gasoline. A __________ externality is present in this example. The marginal social benefit of this activity is _______________ the marginal benefit to the individual. The marginal social cost of the activity is _______________ the marginal cost to the individual. Without intervention, there will be _____________ of this activity.

a. positive; greater than; equal to; too little b. negative; equal to; greater than; too much c. positive; greater than; equal to; too little d. negative; equal to; greater than; too much