Chapter 10
Chapter 10
Chapter 10
Externalities
MULTIPLE CHOICE
6. One advantage market economies have over other types of economies is that market economies
a. provide an equal distribution of goods and services to consumers.
b. establish government economic control.
c. solve the problem of scarcity.
d. are more efficient.
ANSWER: d. are more efficient.
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20. One of the Ten Principles of Economics is that “markets are usually a good way to organize market behavior.” Use
of the word “usually” does NOT reflect the fact that
a. some markets produce negative externalities.
b. the invisible hand of the marketplace does not always lead buyers and sellers to maximize total benefit to
society.
c. some markets are characterized by market failure.
d. other types of economies are more efficient than market economies.
ANSWER: d. other types of economies are more efficient than market economies.
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22. Dioxin emission that results from the production of paper is a good example of a negative externality because
a. self-interested paper firms are generally unaware of environmental regulations.
b. there are fines for producing too much dioxin.
c. self-interested paper producers will not consider the full cost of the dioxin pollution they create.
d. toxic emissions are the only form of an externality.
ANSWER: c. self-interested paper producers will not consider the full cost of the dioxin pollution they create.
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23. If a paper manufacturer does NOT bear the entire cost of the dioxin it emits it will
a. emit lower levels of dioxin than is socially efficient.
b. emit higher levels of dioxin than is socially efficient.
c. emit an acceptable level of dioxin.
d. not emit any dioxin in an attempt to avoid paying the entire cost.
ANSWER: b. emit higher levels of dioxin than is socially efficient.
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25. Policymakers have chosen to solve the problem of too much car exhaust pollution by
a. setting emission standards and limiting driving by commuters.
b. setting emission standards and taxing gasoline.
c. taxing car producers and limiting driving by commuters.
d. taxing gasoline and taxing car producers.
ANSWER: b. setting emission standards and taxing gasoline.
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26. Since restored historic buildings convey a positive externality, local governments may choose to
a. provide tax breaks to owners who restore them.
b. restrict the destruction of historic buildings.
c. increase property taxes in historic areas.
d. All of the above are correct.
e. Both a and b are correct.
ANSWER: e. Both a and b are correct.
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27. Dog owners do not bear the full cost of the noise their barking dogs create and, therefore, tend to take too few
precautions to prevent their dogs from barking. Local governments address this problem by
a. making it illegal to “disturb the peace.”
b. having a well-funded animal control department.
c. subsidizing local animal shelters.
d. encouraging people to buy cats.
ANSWER: a. making it illegal to “disturb the peace.”
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30. Too few resources are generally devoted to research in new technologies in developing countries because
a. new technologies cannot be patented.
b. government research grants are not easily obtainable.
c. negative externalities are created from some research.
d. inventors cannot capture the full benefits of their inventions.
ANSWER: d. inventors cannot capture the full benefits of their inventions.
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34. When externalities are present in a market, the well-being of market participants
a. are directly affected and market bystanders are indirectly affected.
b. and market bystanders are both directly affected.
c. and market bystanders are both indirectly affected.
d. are indirectly affected and market bystanders are directly affected.
ANSWER: a. are directly affected and market bystanders are indirectly affected.
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35. Which of the following statements about a well-maintained yard best conveys the general nature of the externalities?
a. A maintained yard conveys a positive externality because it increases the home’s market value.
b. A maintained yard conveys a negative externality because it increases the property tax liability of the owner.
c. A maintained yard conveys a negative externality because it makes other property owners in the neighborhood
feel like their homes are less valuable.
d. A maintained yard conveys a positive externality because it increases the value of adjacent properties in the
neighborhood.
ANSWER: d. A maintained yard conveys a positive externality because it increases the value of adjacent properties in
the neighborhood.
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36. Hikers frequently claim that livestock grazing in Wilderness Recreation Areas reduces the satisfaction of their
recreational hiking experience. An explanation would be that
a. hikers don’t eat beef.
b. grazing cows create negative externalities which make hiking less pleasant.
c. ranchers are insensitive to the recreational use of public lands.
d. cattle should not be allowed to graze on public property.
ANSWER: b. grazing cows create negative externalities which make hiking less pleasant.
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37. The impact of one person’s actions on the well-being of a bystander is called
a. an economic dilemma.
b. deadweight loss.
c. the third-party problem.
d. an externality.
ANSWER: d. an externality.
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38. An externality
a. is characterized as a form of market failure.
b. causes markets to allocate resources efficiently.
c. strengthens the role of the invisible hand in the marketplace.
d. requires the producer to compensate society.
ANSWER: a. is characterized as a form of market failure.
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42. When a beekeeper places his hives of bees in an orchard so that the bees can gather nectar to produce honey, the
bees pollinate the orchard, which increases the yield of fruit. This benefits
a. only the beekeeper.
b. the beekeeper, but creates a negative externality because the bees are a hazard to the orchard owner.
c. only the owner of the orchard.
d. both the beekeeper and the orchard owner.
ANSWER: d. both the beekeeper and the orchard owner.
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3. At any given quantity, the willingness to pay in the market for automobile fuel is reflected in the
a. value to the consumer of the last unit of automobile fuel bought.
b. height of the supply curve at each quantity.
c. value to the producer of the last unit of automobile fuel sold.
d. total quantity of automobile fuel exchanged in the market.
ANSWER: a. value to the consumer of the last unit of automobile fuel bought.
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46. At any given quantity, the height of the supply curve for pliers shows the
a. willingness to pay of the marginal supplier.
b. willingness to pay of the marginal buyer.
c. cost of the marginal buyer.
d. cost of the marginal seller.
ANSWER: d. cost of the marginal seller.
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47. The height of the supply curve at any given quantity of coal shows the
a. value to the consumer of the last unit of coal bought.
b. consumer's willingness to pay for coal at each quantity.
c. cost to the producer of the last unit of coal sold.
d. total quantity of coal exchanged in the market.
ANSWER: c. cost to the producer of the last unit of coal sold.
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48. Without government intervention, the market equilibrium for oranges will
a. maximize total surplus in the market.
b. be both efficient and equitable.
c. not adjust, even if demand or supply changes.
d. not allocate resources efficiently.
ANSWER: a. maximize total surplus in the market.
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51. According to the graph, producer and consumer surplus at the point of market efficiency is represented by area(s)
a. a + d.
b. b + c
c. c + d
d. a + b
ANSWER: d. a+b
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52. According to the graph, consumer surplus would be maximized at what price and quantity combination?
a. P1and Q1.
b. P2 and 0.
c. P0 and 0.
d. P0 and Q1.
ANSWER: c. P0 and 0.
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54. Suppose that large-scale pork production has the potential to create ground water pollution. Why might this type of
pollution be considered an externality?
a. The groundwater pollution reduces the cost of large-scale pork production.
b. The economic impact of a large-scale pork production facility is localized in a small geographic area.
c. The pollution has the potential for creating a health risk for water users in the region surrounding the pork
production facility.
d. Consumers will not reap the benefits of lower production cost from large-scale pork production.
ANSWER: c. The pollution has the potential for creating a health risk for water users in the region surrounding the
pork production facility.
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55. Markets are often inefficient when negative externalities are present because
a. private costs exceed social costs at the private market solution.
b. externalities can never be corrected without government regulation.
c. social costs exceed private costs at the private market solution.
d. production externalities lead to consumption externalities.
ANSWER: c. social costs exceed private costs at the private market solution.
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56. The difference between social cost and private cost is a measure of the
a. cost of a negative externality.
b. loss in profit to the seller as the result of a negative externality.
c. cost reduction when the negative externality is eliminated.
d. cost incurred by the government from market intervention.
ANSWER: a. cost of a negative externality.
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57. When the social cost curve is above a product’s supply curve we know that
a. government has intervened in the market.
b. a negative externality exists in the market.
c. a positive externality exists in the market.
d. the market reached equilibrium on its own.
ANSWER: b. a negative externality exists in the market.
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60. According to the graph, the optimum amount of this product from society’s standpoint would be
a. Q1.
b. Q2.
c. Q3.
d. Q4.
ANSWER: b. Q2.
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62. According to the graph, if this market currently produces Q3, total economic well-being would be increased if
a. production decreased to Q2.
b. production increased to Q4.
c. this product were no longer produced.
d. Since well-being is maximized at Q3 it cannot be increased.
ANSWER: a. production decreased to Q2.
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64. According to the graph, the social cost curve is above the supply curve because
a. it takes into account the external costs imposed on society by the concert organizers.
b. municipalities always impose noise restrictions on concerts in parks surrounded by residential neighborhoods.
c. concert tickets are likely to cost more than the concert actually costs the organizers.
d. residents in the surrounding neighborhoods get to listen to the concert for free.
ANSWER: a. it takes into account the external costs imposed on society by the concert organizers.
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65. According to the graph, the difference between the social cost curve and the supply curve reflects the
a. profit margin of each concert.
b. cost of spillover effects from the concert (e.g., noise and traffic).
c. value of concerts to society as a whole.
d. amount by which the city should subsidize the concert organizers.
ANSWER: b. cost of spillover effects from the concert (e.g., noise and traffic).
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66. According to the graph, what price and quantity combination best represents the optimum price and number of
concerts that should be organized?
a. P1, Q1
b. P2, Q0
c. P3, Q1
d. The optimum quantity is zero concerts as long as residents in surrounding neighborhoods are adversely affected
by noise and congestion.
ANSWER: b. P 2 Q0
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67. Assume that the concert organizers must purchase a concert permit (the cost for the permit is included in private
cost) before organizing the concert. What criteria should the city use in determining whether or not to issue a
permit?
a. The majority vote of the residents in surrounding neighborhoods should determine whether a permit is issued.
b. As long as the value to consumers of concerts exceeds the cost of concerts (including the external costs) the
permit should be issued.
c. As long as concert organizers are willing to return the park to its original condition after the concert, the permit
should be issued.
d. The permit should not be issued as long as there are identifiable external costs imposed on residents in
surrounding neighborhoods.
ANSWER: b. As long as the value to consumers of concerts exceeds the cost of concerts (including the external costs)
the permit should be issued.
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68. Total surplus derived from the most efficient outcome is represented by the area
a. a + b.
b. a + b +c +d +e +f.
c. a + b +c +e +g.
d. a + b + c +d.
ANSWER: a. a + b.
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69. According to the graph, at the private market outcome, the equilibrium price will be
a. P0.
b. P1.
c. P2.
d. P3.
ANSWER: b. P1.
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71. Suppose that a steel factory emits a certain amount of air pollution and which constitutes a negative externality. If
this market is not required to internalize this externality,
a. the supply curve would adequately reflect the marginal social cost of production.
b. consumers will be required to pay a higher price for steel than they would have if the externality were
internalized.
c. the market equilibrium would not be the socially optimal quantity.
d. producers will produce less steel than they otherwise would have if the externality were internalized.
ANSWER: c. the market equilibrium would not be the socially optimal quantity.
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72. A fertilizer plant emits a very foul odor during the production process. If the government forces the plant to
internalize this negative externality, then the
a. supply curve for fertilizer would shift to the right (down).
b. supply curve for fertilizer would shift to the left (up).
c. demand curve for fertilizer would shift to the right (down).
d. demand curve for fertilizer would shift to the left (up).
ANSWER: b. supply curve for fertilizer would shift to the left (up).
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73. Suppose that a steel factory emits a certain amount of air pollution, which constitutes a negative externality. The
social cost of producing the steel includes the
a. private costs of the steel producers and the price consumers pay for the steel.
b. private costs of the steel producers and the costs to the bystanders affected by the pollution.
c. costs to the bystanders effected by the pollution only.
d. price consumers pay for the steel.
ANSWER: b. private costs of the steel producers and the costs to the bystanders affected by the pollution.
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74. Which of the following statements is most correct about a market which is characterized by a negative production
externality?
a. The equilibrium quantity of output is equal to the socially optimal quantity.
b. The equilibrium quantity of output is greater than the socially optimal quantity.
c. Government intervention is not required to achieve a socially optimal quantity of output.
d. The cost to the producer exceeds the cost to society.
ANSWER: b. The equilibrium quantity of output is greater than the socially optimal quantity.
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75. When a market is in equilibrium and the marginal consumer values a commodity at less than the social cost of
producing it, then
a. at market equilibrium the demand curve lies below the social cost curve.
b. reducing production to a level below the equilibrium level could possibly raise total economic well-being.
c. the equilibrium price is higher than necessary to insure maximum economic well-being.
d. All of the above are correct.
e. Both a and b are correct.
ANSWER: e. Both a and b are correct.
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76. When producers operate in a market characterized by negative externalities, a tax that forces them to internalize the
externality will
a. give sellers the incentive to account for the external effects of their actions.
b. have an offsetting effect that reduces the producers’ private production costs.
c. increase the amount of the commodity exchanged in market equilibrium.
d. restrict the producers’ ability to take the costs of the externality into account when deciding how much to
supply.
ANSWER: a. give sellers the incentive to account for the external effects of their actions.
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78. According to the graph, the equilibrium quantity in this market would be
a. Q1.
b. Q2.
c. Q3.
d. Q4.
ANSWER: b. Q2.
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79. According to the graph, the optimum amount of this product from society’s standpoint would be at
a. Q1.
b. Q2.
c. Q3.
d. Q4.
ANSWER: c. Q3.
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81. According to the graph, if this market currently produces Q2, total economic well-being would be increased if
a. production decreased to Q1.
b. production increased to Q3.
c. this product were no longer produced.
d. since well-being is maximized at Q2 it cannot be increased.
ANSWER: b. production increased to Q3.
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84. Which price and quantity combination represents the social optimum?
a. P0 and Q1.
b. P2 and Q1.
c. P1 and Q2.
d. P2 and Q2.
ANSWER: b. P2 and Q1.
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85. Internalizing a positive externality will cause the supply curve faced by an industry to
a. shift to the right.
b. shift to the left.
c. become more elastic.
d. remain unchanged.
ANSWER: a. shift to the right.
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86. Internalizing a negative externality will cause the supply curve faced by an industry to
a. shift to the right.
b. shift to the left.
c. expand.
d. remain unchanged.
ANSWER: b. shift to the left.
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87. Which of the following is true concerning government attempts to internalize externalities?
a. Government should tax goods with negative externalities and subsidize goods with positive externalities.
b. Government should tax goods with either positive or negative externalities.
c. Government should subsidize goods with either positive or negative externalities.
d. Government should tax goods with positive externalities and subsidize goods with negative externalities.
ANSWER: a. Government should tax goods with negative externalities and subsidize goods with positive
externalities.
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88. Which of the following statements about internalizing a negative externality is most correct?
a. Internalizing a negative externality will cause an industry to decrease the quantity it supplies to the market and
decrease the price of the good produced.
b. Internalizing a negative externality will cause an industry to decrease the quantity it supplies to the market and
increase the price of the good produced.
c. Internalizing a negative externality will cause an industry to increase the quantity it supplies to the market and
decrease the price of the good produced.
d. Internalizing a negative externality will cause an industry to increase the quantity it supplies to the market and
increase the price of the good produced.
ANSWER: b. Internalizing a negative externality will cause an industry to decrease the quantity it supplies to the
market and increase the price of the good produced.
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92. Which of the following best defines the situation where one firm’s research yields knowledge that is used by society
as a whole?
a. social cost
b. opportunity cost of technology
c. internalization of an externality
d. technology spillover
ANSWER: d. technology spillover
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94. If the government wanted to ensure that the market reaches the social optimum in the presence of a technology
spillover, it should
a. impose a Pigovian tax on any firm producing a technology spillover.
b. offer tax credits to consumers who are adversely affected by the new technology.
c. subsidize producers by an amount equal to the value of the technology spillover.
d. provide research grants to those firms not currently engaging in research to increase competition in the industry.
ANSWER: c. subsidize producers by an amount equal to the value of the technology spillover.
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95. Which of the following statements about a market that is affected by a positive externality is correct?
a. The optimum level of output is less than the free market level of output and the optimum price is greater than
the free market price.
b. The optimum level of output is greater than the free market level of output and the optimum price is less than
the free market price.
c. The optimum level of output is greater than the free market level of output and the optimum price is greater
than the free market price.
d. The optimum level of output is less than the free market level of output and the optimum price is less than the
free market price.
ANSWER: b. The optimum level of output is greater than the free market level of output and the optimum price is less
than the free market price.
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97. To enhance the well-being of society, a social planner will encourage firms to increase production when
a. the firms are producing basic goods.
b. there is a shortage in the market.
c. technology spillovers are associated with production.
d. any negative externalities associated with production are imposed only upon consumers.
ANSWER: c. technology spillovers are associated with production.
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99. Internalizing a positive externality through a government subsidy will cause the industry’s supply curve to
a. remain unchanged.
b. shift down by an amount less than the subsidy.
c. shift down by an amount equal to the subsidy.
d. shift down by an amount greater than the subsidy.
ANSWER: c. shift down by an amount equal to the subsidy.
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100. To ensure the market reaches the social optimum in presence of a technology spillover, the government should
subsidize producers by
a. use of a Pigovian tax
b. an amount equal to the value of the technology spillover
c. helping those companies that are adversely affected by the new technology.
d. transferring income to the low-income portion of the population.
ANSWER: b. an amount equal to the value of the technology spillover
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101. With technology spillover, to ensure that the market equilibrium equals the social optimum, government should
a. impose a tax greater than the value of the technology spillover.
b. not allow production of any product that causes a technology spillover.
c. provide a subsidy equal to the value of the technology spillover.
d. require producers to “clean up” any spillover that results from their production process.
ANSWER: c. provide a subsidy equal to the value of the technology spillover.
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102. If making computer chips yields greater spillovers than making potato chips, some economists would argue that
government should
a. encourage the production of computer chips with subsidies.
b. discourage the production of potato chips with taxes.
c. encourage the production of potato chips with subsidies.
d. discourage the production of computer chips with taxes.
ANSWER: a. encourage the production of computer chips with subsidies.
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111. According to the graph shown, which price and quantity combination represents the social optimum for this
market?
a. P1 and Q1.
b. P2 and Q2.
c. P2 and Q1.
d. P3 and Q1.
ANSWER: a. P1 and Q1.
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112. According to the graph shown, to internalize the externality in this market the government should
a. impose a tax on this product.
b. provide a subsidy for this product.
C. encourage firms to supply more of this product by offering tax incentives.
d. produce the product itself.
ANSWER: a. impose a tax on this product.
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115. According to the graph shown, which price and quantity combination represents the social optimum for this
market?
a. P1 and Q1.
b. P2 and Q2.
c. P2 and Q1.
d. P3 and Q1.
ANSWER: b. P2 and Q2.
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116. According to the graph shown, to internalize the externality in this market the government should
a. impose a tax on this product.
b. provide a subsidy for this product.
c. encourage firms to supply more of this product by taxing them.
d. produce the product itself.
ANSWER: b. provide a subsidy for this product.
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118. When dealing with externalities, the market equilibrium can be moved closer to the social equilibrium by
a. taxing negative externalities and subsidizing positive externalities.
b. taxing both positive and negative externalities.
c. subsidizing both positive and negative externalities.
d. None of the above are correct because government has no corrective policy with regards to externalities.
ANSWER: a. taxing negative externalities and subsidizing positive externalities.
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119. Private markets fail to reach a socially optimal level when negative externalities are present because
a. social costs equal private costs at the private market solution.
b. private costs exceed social costs at the private market solution.
c. social costs exceed private costs at the private market solution.
d. they internalize externalities.
ANSWER: c. social costs exceed private costs at the private market solution.
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120. Private markets fail to reach a socially optimal level when positive externalities are present because.
a. private benefit equals social benefit at the private market solution.
b. private costs exceed private benefits at the private market solution.
c. social value exceeds private value at the private market solution.
d. private costs exceed social benefit at the private market solution.
ANSWER: c. social value exceeds private value at the private market solution.
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123. Since externalities tend to keep markets from reaching a socially optimal equilibrium, government action
a. is always needed, because private solutions can never be attained.
b. is needed when private solutions fail to arise.
c. will be needed only to correct for positive externalities.
d. will be needed only to compensate consumers.
ANSWER: b. is needed when private solutions fail to arise.
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125. Many times the problems of externalities are solved by each of the following EXCEPT
a. self-interest.
b. moral codes and social sanctions.
c. charity.
d. normal market adjustments.
ANSWER: d. normal market adjustments.
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126. Firms that are involved in different types of business could be evidence of an attempt to
a. increase private profit at the expense of consumers.
b. internalize some forms of positive externalities.
c. reduce the impact of government regulation on their business.
d. increase the marginal external cost of production.
ANSWER: b. internalize some forms of positive externalities.
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131. Two ways that private markets can solve the problem of externalities is with
a. integrating businesses and subsidies.
b. contracts and patents.
c. integrating businesses and contracts.
d. subsidies and patents.
ANSWER: c. integrating businesses and contracts.
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132. Which of the following choices suggests that the private market can be effective in dealing with externalities?
a. the “invisible hand”
b. the law of diminishing social returns
c. the Coase theorem
d. technology policy
ANSWER: c. the Coase theorem
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133. According to the Coase theorem, private parties can solve the problem of externalities if
a. the cost of bargaining is small.
b. the initial distribution of rights favors the person being adversely affected by the externality.
c. the number of parties involved is sufficiently large.
d. All of the above are correct.
ANSWER: a. the cost of bargaining is small.
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134. According to the Coase theorem, private markets will solve externality problems and allocate resources efficiently as
long as
a. private parties can bargain without cost.
b. government assigns property rights to the harmed party.
c. the externalities that are present are positive and not negative.
d. businesses determine an appropriate level of production.
ANSWER: a. private parties can bargain without cost.
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135. Dick owns a dog whose barking annoys Dick’s neighbor Jane. Suppose that the benefit of owning the dog is worth
$500 to Dick and that Jane bears a cost of $700 from the barking. Assuming Dick has the legal right to keep the dog, a
possible private solution to this problem is that
a. Jane pays Dick $500 to get rid of the dog.
b. Dick pays Jane $650 for her inconvenience.
c. Jane pays Dick $650 to get rid of the dog.
d. There is no private solution that would improve this situation.
ANSWER: c. Jane pays Dick $650 to get rid of the dog.
TYPE: M SECTION: 2 DIFFICULTY:3
136. Dick owns a dog whose barking annoys Dick’s neighbor Jane. Suppose that the benefit of owning the dog is worth
$700 to Dick and that Jane bears a cost of $500 from the barking. Assuming Dick has the legal right to keep the dog, a
possible private solution to this problem is that
a. There is no private solution that would improve this situation.
b. Jane pays Dick $650 to get rid of the dog.
c. Jane pays Dick $800 to get rid of the dog.
d. Dick pays Jane $600 for her inconvenience.
ANSWER: a. There is no private solution that would improve this situation.
TYPE: M SECTION: 2 DIFFICULTY:3
137. Dick owns a dog whose barking annoys Dick’s neighbor Jane. Dick receives personal benefit from owning the dog,
and Jane bears a cost of Dick’s ownership of the dog. Assuming Dick has the legal right to keep the dog, which of
the following choices are true?
a. A private solution can always be arranged.
b. A private solution can be arranged only if the cost Jane bears exceeds the benefit Dick gets from his dog.
c. A private solution can be arranged only if Jane’s cost equals Dick’s benefit from the dog.
d. A private solution can be arranged only if Dick’s benefit from his dog exceeds Jane’s cost.
ANSWER: b. A private solution can be arranged only if the cost Jane bears exceeds the benefit Dick gets from his dog.
TYPE: M SECTION: 2 DIFFICULTY:3
138. Dick owns a dog whose barking annoys Dick’s neighbor Jane. Dick receives personal benefit from owning the dog,
and Jane bears a cost of Dick’s ownership of the dog. Assuming Jane has the legal right to peace and quiet, which of
the following statements is true?
a. If Dick’s benefit exceeds Jane’s cost, government intervention is necessary.
b. Dick will pay to keep his dog if his benefit exceeds Jane’s cost.
c. If Jane’s cost exceeds Dick’s benefit, Dick will pay Jane to keep his dog.
d. If Jane has legal right to peace and quiet, she only has to pay Dick when her cost is below his benefit.
ANSWER: b. Dick will pay to keep his dog if his benefit exceeds Jane’s cost.
TYPE: M SECTION: 2 DIFFICULTY: 2
Chapter 10/Externalities 301
139. Chad’s maple tree hangs over Amy’s fence and drops leaves into her yard each autumn. The benefit to Chad of
lower utility bills is about $300. The cost to Amy of having her lawn cleaned and reseeded is $350. Based on the
Coase theorem
a. Amy should pay Chad $325 to cut down the tree.
b. Chad should pay Amy $350 to have her lawn repaired and cleaned.
c. Chad should pay Amy $400 to keep the tree.
d. Amy should build a higher fence.
ANSWER: a. Amy should pay Chad $325 to cut down the tree.
TYPE: M SECTION: 2 DIFFICULTY:3
141. The Coase theorem suggests that private markets may not be able to solve the problem of externalities
a. when the number of interested parties is large and bargaining costs are high.
b. if government does not actively become involved in the process.
c. if the firm in the market is a monopoly.
d. if some people benefit from the externality.
ANSWER: a. when the number of interested parties is large and bargaining costs are high.
TYPE: M SECTION: 2 DIFFICULTY:2
143. Private solutions often are not possible due to the costs of negotiating and enforcing these solutions. Such costs are
called
a. transaction costs.
b. opportunity costs.
c. deadweight loss.
d. Pigovian taxes.
ANSWER: a. transaction costs.
TYPE: M SECTION: 2 DIFFICULTY: 1
145. One reason private solutions to externalities do not always work is because
a. government participation in such solutions complicates the process.
b. some people benefit from externalities.
c. interested parties incur costs in the bargaining process.
d. the actual costs and benefits of the problem are different to determine.
ANSWER: c. interested parties incur costs in the bargaining process.
TYPE: M SECTION: 2 DIFFICULTY:2
146. When parties who are bargaining to eliminate an externality problem hold out for a better deal
a. the inefficient outcome persists.
b. the eventual outcome will maximize total well-being.
c. transaction costs must be low.
d. one party will gain more than the other party.
ANSWER: a. the inefficient outcome persists.
TYPE: M SECTION: 2 DIFFICULTY:2
147. Assuming transaction costs are small, the Coase Theorem is likely to be helpful in articulating a solution to a
a. neighborhood problem with unattended dogs running loose.
b. neighbor who doesn’t care for his yard.
c. neighbor who deals drugs out of his house.
d. All of the above are correct.
ANSWER: d. All of the above are correct.
TYPE: M SECTION: 2 DIFFICULTY: 1
148. If only a few people are affected by an externality, then it is likely that
a. Pigovian taxes will provide the most efficient solution to the externality.
b. command and control regulation will provide the most efficient solution to the externality.
c. a private solution to the inefficiency will occur.
d. a private solution will be very difficult to negotiate.
ANSWER: c. a private solution to the inefficiency will occur.
TYPE: M SECTION: 2 DIFFICULTY: 2
150. Employing a lawyer to draft and enforce a private contract between parties wishing to solve an externality problem
is an example of
a. an opportunity cost.
b. an implicit cost.
c. a sunk cost.
d. a transaction cost.
ANSWER: d. a transaction cost.
TYPE: M SECTION: 2 DIFFICULTY: 1
151. Which of the following is one problem that keeps people from privately solving externalities?
a. Each party involved holds out for a better deal.
b. The externality is large.
c. Only problems with a sufficiently large number of parties can be solved.
d. There is a lack of government intervention.
ANSWER: a. Each party involved holds out for a better deal.
TYPE: M SECTION: 2 DIFFICULTY: 2
Chapter 10/Externalities 303
152. In class action lawsuits interested parties to the lawsuit are not required to pay attorney fees directly. This is an
example of an attempt to
a. increase attorney fees from a final judgment.
b. reduce the incentive of attorneys to take on class-action law suits.
c. reduce the transaction costs of finding a private solution to an externality.
d. regulate attorney fees in class action lawsuits.
ANSWER: c. reduce the transaction costs of finding a private solution to an externality.
TYPE: M SECTION: 2 DIFFICULTY: 2
153. Nancy loves to landscape her yard, but her neighbor Lee places a low value on his landscaping. When Lee’s grass is
neglected and gets long, Nancy will mow it for Lee. This is an example of
a. a situation in which the Coase theorem fails to explain the lawn mowing arrangement.
b. improper allocation of resources.
c. a private solution to a negative externality problem.
d. an exploitation of a common resource.
ANSWER: c. a private solution to a negative externality problem.
TYPE: M SECTION: 2 DIFFICULTY: 2
154. The Coase theorem suggests that private solutions to the externality problem
a. will always allocate resources efficiently if private parties can bargain without cost.
b. are effective under all conditions.
c. are only efficient when there are negative externalities.
d. may not be possible because of the distribution of property rights.
ANSWER: a. will always allocate resources efficiently if private parties can bargain without cost.
TYPE: M SECTION: 2 DIFFICULTY: 2
155. Assume that your roommate, Vanessa, is very messy, which is not a crime at your campus. Suppose she gets a $100
benefit from being messy but imposes a $200 cost on you. The Coase theorem would suggest that an efficient
solution would be for you to
a. pay your roommate at least $100 but no more than $200 to clean up after herself.
b. pay your roommate at least $201 to clean up after herself.
c. charge your roommate at least $100 to have you clean up after her.
d. charge your roommate at least $200 but no more than $300 to keep you from complaining about the mess.
ANSWER: a. pay your roommate at least $100 but no more than $200 to clean up after herself.
TYPE: M SECTION: 2 DIFFICULTY: 2
156. Assume that your roommate, Vanessa, is very messy, and according to campus policy, you have a right to live in an
uncluttered apartment. Suppose she gets a $200 benefit from being messy but imposes a $100 cost on you. The Coase
theorem would suggest that an efficient solution would be for your roommate to
a. stop her messy habits or else move out.
b. pay you at least $100 but less than $200 to live with the clutter.
c. continue to be messy and force you to make other living arrangements elsewhere.
d. demand payment of at least $100 but no more than $200 to clean up after herself.
ANSWER: b. pay you at least $100 but less than $200 to live with the clutter.
TYPE: M SECTION: 2 DIFFICULTY: 2
158. When the government chooses an externality policy that aligns private incentives with social efficiency to solve an
externality,
a. it provides incentives to private decision makers to induce them to solve the externality problem on their own.
b. it typically uses command-and-control techniques.
c. the use of taxes is strictly forbidden.
d. subsidies are always the best policy.
ANSWER: a. it provides incentives to private decision makers to induce them to solve the externality problem on their
own.
TYPE: M SECTION: 3 DIFFICULTY: 2
159. A local cafe which allowed patrons to smoke was recently forced to close its doors because it did not comply with
local clean air standards. This decision provides an example of
a. direct regulation of an externality.
b. Pigovian taxes.
c. a Coase theorem solution to an externality.
d. unjustified discrimination against smokers.
ANSWER: a. direct regulation of an externality.
TYPE: M SECTION: 3 DIFFICULTY: 2
160. In Singapore, littering fines are strictly enforced. This is an example of a policy
a. in which moral codes and social sanctions reduce the pollution externality.
b. that relies on command and control techniques.
c. that discriminates against foreigners.
d. in which private incentives are used to reduce the pollution externality in Singapore.
ANSWER: d. a policy in which private incentives are used to reduce the pollution externality in Singapore.
TYPE: M SECTION: 3 DIFFICULTY: 2
162. Since almost all forms of transportation produce some type of pollution
a. the government should ban all transportation.
b. society has to weigh the cost and benefits and decide how much pollution to allow.
c. corporations should voluntarily reduce pollution levels with new car models.
d. the government should tax the types of transportation that pollute most to eliminate it altogether.
ANSWER: b. society has to weigh the cost and benefits and decide how much pollution to allow.
TYPE: M SECTION: 3 DIFFICULTY: 2
163. Pigovian taxes are typically advocated to correct for the effects of
a. positive externalities.
b. negative externalities.
c. regulatory burden.
d. All of the above are correct.
ANSWER: b. negative externalities.
TYPE: M SECTION: 3 DIFFICULTY: 2
Chapter 10/Externalities 305
166. Pigovian taxes are preferred over regulations to deal with pollution because Pigovian taxes
a. reduce pollution at a lower cost to society.
b. raise revenue and reduce pollution simultaneously, although efficiency is reduced.
c. obtain faster results than regulations.
d. allow for an accurate monitoring of pollution levels.
ANSWER: a. reduce pollution at a lower cost to society.
TYPE: M SECTION: 3 DIFFICULTY: 2
169. Pigovian taxes differ from most taxes in that Pigovian taxes
a. enhance economic efficiency.
b. do not raise revenue from the government.
c. cause deadweight loss.
d. cannot be divided between the buyer and seller.
ANSWER: a. enhance economic efficiency.
TYPE: M SECTION: 3 DIFFICULTY: 2
306 Chapter 10/Externalities
171. If the government were to limit the release of air-pollution produced by a steel mill to 10,000 units, this policy would
be considered a
a. regulation.
b. Pigovian tax.
c. subsidy.
d. market-based policy.
ANSWER: a. regulation.
TYPE: M SECTION: 3 DIFFICULTY: 1
172. If the government were to impose a fee of $10,000 for each unit of air-pollution released by a steel mill, this policy
would be considered a
a. subsidy.
b. regulation.
c. Pigovian tax.
d. command-and-control policy.
ANSWER: c. Pigovian tax.
TYPE: M SECTION: 3 DIFFICULTY: 1
173. According to the graphs, which curve best represents a Pigovian tax?
a. A
b. B
c. C
d. D
ANSWER: a. A
TYPE: M SECTION: 3 DIFFICULTY: 3
Chapter 10/Externalities 307
174. According to the graphs, the equivalence of a Pigovian tax and a pollution permit would require each of the
following EXCEPT that
a. PB be equivalent to the Pigovian tax.
b. QA be equivalent to the amount of pollution allowed by the pollution permit holders.
c. the equilibrium price and quantity of pollution are the same in both panel A and panel B.
d. the amount of pollution emitted by each firm to be the same.
ANSWER: d. the amount of pollution emitted by each firm to be the same.
TYPE: M SECTION: 3 DIFFICULTY: 3
176. Pigovian taxes are unlike most other taxes because they
a. distort incentives.
b. move the allocation of resources away from the social optimum.
c. raise revenue for the government.
d. move the allocation of resources closer to the social optimum.
ANSWER: d. move the allocation of resources closer to the social optimum.
TYPE: M SECTION: 3 DIFFICULTY: 3
179. The gas tax is imposed to correct each of the following EXCEPT
a. congestion.
b. accidents.
c. pollution.
d. income inequality.
ANSWER: d. income inequality.
TYPE: M SECTION: 3 DIFFICULTY: 1
308 Chapter 10/Externalities
180. One advantage of allowing a market for pollution permits to control the total amount of pollution released in an
area is that
a. the government knows exactly how much each firm is allowed to pollute.
b. government revenue from the sale of permits is greater than revenue from a Pigovian tax.
c. the initial allocation of permits to firms does not affect the efficiency of the market.
d. firms will work together to eventually eliminate pollution.
ANSWER: c. the initial allocation of permits to firms does not affect the efficiency of the market.
TYPE: M SECTION: 3 DIFFICULTY: 3
181. Two ways to reduce pollution which require firms to pay to pollute are
a. Pigovian taxes and pollution permits.
b. Pigovian taxes and a command-and-control policy.
c. pollution permits and a command-and-control policy.
d. pollution regulations and pollution permits.
ANSWER: a. Pigovian taxes and pollution permits.
TYPE: M SECTION: 3 DIFFICULTY: 2
183. In some cases, pollution permits may be better than a Pigovian tax because
a. pollution permits allow for a market solution while a Pigovian tax does not.
b. pollution permits generate more revenue for the government than a Pigovian tax.
c. Pollution permits are never preferred over a Pigovian tax.
d. the government can set a maximum level of pollution using permits.
ANSWER: d. the government can set a maximum level of pollution using permits.
TYPE: M SECTION: 3 DIFFICULTY: 2
184. With a Pigovian tax, the supply curve for pollution rights is
a. elastic.
b. perfectly elastic.
c. inelastic.
d. perfectly inelastic.
ANSWER: b. perfectly elastic.
TYPE: M SECTION: 3 DIFFICULTY: 2
185. With pollution permits, the supply curve for pollution rights is
a. elastic.
b. perfectly elastic.
c. inelastic.
d. perfectly inelastic.
ANSWER: d. perfectly inelastic.
TYPE: M SECTION: 3 DIFFICULTY: 2
187. When one firm sells its pollution permit to another firm, which of the following does NOT occur?
a. Both firms benefit.
b. The total amount of pollution remains the same.
c. Social welfare is enhanced.
d. Over time, pollution will be eliminated.
ANSWER: d. Over time, pollution will be eliminated.
TYPE: M SECTION: 3 DIFFICULTY: 2
188. Some environmentalists argue that we should protect the environment as much as possible, regardless of cost. The
implication of such a disregard for cost is likely to lead to each of the following EXCEPT
a. lower levels of nutrition, health care, and housing.
b. a lower standard of living.
c. slowing or reversing technological advancement.
d. the elimination of all production that emits pollution.
ANSWER: d. the elimination of all production that emits pollution.
TYPE: M SECTION: 3 DIFFICULTY: 2
190. According to an article in The Economist, negative externalities in the form of noise pollution can be caused by
a. barking dogs.
b. mobile phones.
c. public transportation.
d. children.
ANSWER: d. children.
TYPE: M SECTION: 3 DIFFICULTY: 2
193. Children can be thought of as imposing negative externalities on airplane passengers because
a. when they cry, passengers bear a portion of the cost.
b. their tickets are free or obtained at reduced cost.
c. children (and their parents) are typically isolated in the rear of the airplane.
d. All of the above are correct.
ANSWER: a. when they cry, passengers bear a portion of the cost.
TYPE: M SECTION: 3 DIFFICULTY: 2
310 Chapter 10/Externalities
195. Which of the following policies is government most inclined to use when faced with a positive externality?
a. taxation
b. permits
c. subsidies
d. usage fees
ANSWER: c. subsidies
TYPE: M SECTION: 3 DIFFICULTY: 1
196. If it is illegal for a biochemical manufacturer to release its waste into a nearby stream, then this is an example of
a. a market-based policy.
b. a command-and-control policy.
c. pollution permits.
d. transaction costs.
ANSWER: b. a command-and-control policy.
TYPE: M SECTION: 3 DIFFICULTY: 2
197. Suppose that at present there are no laws to restrict pollution produced by the widget industry. The market price of
a widget is $20. Under what circumstances should the government consider taking action to reduce pollution by the
widget industry?
a. If the cost imposed by the pollution is less than $20 per widget produced, no action is necessary.
b. If $20 minus the private cost of producing a widget equals the cost of the pollution generated per widget, then
the government should act to reduce pollution.
c. If $20 minus the private cost of producing a widget is greater than the cost of the pollution generated per widget,
then the government should act to reduce pollution.
d. If $20 minus the private cost of producing a widget is less than the cost of the pollution generated per widget,
then the government should act to reduce pollution.
ANSWER: d. If $20 minus the private cost of producing a widget is less than the cost of the pollution generated per
widget, then the government should act to reduce pollution.
TYPE: M SECTION: 1 DIFFICULTY: 3
198. Anita enjoys growing flowers in her yard and has a lot of spare time, but can’t afford the $100 it costs to buy flower
seeds, fertilizer and water. Sally, who has a good view of Anita’s yard, would also enjoy Anita’s flowers. Sally has
plenty of money but has no time to plant flowers. According to the Coase Theorem,
a. the city government should give Anita the $100 needed to grow flowers.
b. the city government should require Anita to grow flowers.
c. Sally and Anita might both be better off if Sally gave $100 to Anita to plant flowers.
d. Sally and Anita would definitely both be better off if Sally gave $100 to Anita to plant flowers.
ANSWER: c. Sally and Anita might both be better off if Sally gave $100 to Anita to plant flowers.
TYPE: M SECTION: 2 DIFFICULTY: 3
199. In which of the following cases is the Coase Theorem most likely to work to solve the externality?
a. Richard is annoyed because his roommate smokes.
b. Chemicals from farms in the Mississippi Valley are polluting the Gulf of Mexico.
c. Car exhaust in a small town is making one of its residents ill.
d. Industrialization around the world is causing acid rain.
ANSWER: a. Richard is annoyed because his roommate smokes.
TYPE: M SECTION: 2 DIFFICULTY: 2
Chapter 10/Externalities 311
200. A local laundry advertises that clothes it washes smell “sunshine fresh” because it line dries everything outside.
Then a steel factory moves in next door and emits black smoke which stains the clothes drying at the laundry.
According to the Coase Theorem, granting the
a. steel factory the right to pollute would be efficient, but granting the laundry the right to clean air would be
equitable.
b. laundry the right to clean air would be efficient, but granting the steel factory the right to pollute would be
equitable.
c. steel factory the right to pollute has the same effect on equity as granting the laundry the right to clean air.
d. steel factory the right to pollute has the same effect on efficiency as granting the laundry the right to clean air.
ANSWER: d. steel factory the right to pollute has the same effect on efficiency as granting the laundry the right to
clean air.
TYPE: M SECTION: 2 DIFFICULTY: 2
202. Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the
river. The government gives each firm 20 pollution permits, which it can either use or sell to the other firm. It costs
Firm A $100 for each ton of pollution that it eliminates before it reaches the river and it costs Firm B $50 for each ton
of pollution that it eliminates before it reaches the river. After the two firms buy or sell pollution permits from each
other, we would expect that Firm A will dump
a. 10 fewer tons of pollution into the river and Firm B will dump 50 fewer tons of pollution into the river.
b. 50 fewer tons of pollution into the river and Firm B will dump 10 fewer tons of pollution into the river.
c. 30 fewer tons of pollution into the river and Firm B will dump 30 fewer tons of pollution into the river.
d. 10 more tons of pollution into the river and Firm B will dump 50 fewer tons of pollution into the river.
ANSWER: a. 10 fewer tons of pollution into the river and Firm B will dump 50 fewer tons of pollution into the river.
TYPE: M SECTION: 3 DIFFICULTY: 3
203. Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the
river. The government gives each firm 20 pollution permits, which it can either use or sell to the other firm. It costs
Firm A $100 for each ton of pollution that it eliminates before it reaches the river and it costs Firm B $50 for each ton
of pollution that it eliminates before it reaches the river. It is likely that
a. Firm A will buy all of Firm B’s pollution permits. Each one will cost between $50 and $100.
b. Firm B will buy all of Firm A’s pollution permits. Each one will cost between $50 and $100.
c. Both firms will use their own pollution permits.
d. Firm A will buy all of Firm B’s pollution permits. Each one will cost less than $50.
ANSWER: a. Firm A will buy all of Firm B’s pollution permits. Each one will cost between $50 and $100.
TYPE: M SECTION: 3 DIFFICULTY: 3
312 Chapter 10/Externalities
204. Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the
river. It costs Firm A $100 for each ton of pollution that it eliminates before it reaches the river and it costs Firm B
$50 for each ton of pollution that it eliminates before it reaches the river. The government gives each firm 20
pollution permits. Government officials are not sure whether to allow the firms to buy or sell the pollution permits
to each other. What is the total cost of reducing pollution if firms are not allowed to buy and sell pollution permits
from each other? What is the total cost of reducing pollution if the firms are allowed to buy and sell permits from
each other?
a. $3,000; $1,500
b. $4,500; $3,000
c. $4,000; $4,000
d. $3,500; $2,500
ANSWER: b. $4,500; $3,000
TYPE: M SECTION: 3 DIFFICULTY: 3
205. Two firms, A and B, each currently dump 20 tons of chemicals into the local river. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the
river. The government gives each firm 10 pollution permits, which it can either use or sell to the other firm. It costs
Firm A $100 for each ton of pollution that it eliminates before it reaches the river and it costs Firm B $50 for each ton
of pollution that it eliminates before it reaches the river. After the two firms buy or sell pollution permits from each
other, we would expect that
a. Firm A will no longer pollute and Firm B will not reduce its pollution at all.
b. Firm B will no longer pollute and Firm A will not reduce its pollution at all.
c. Firm A will dump 10 tons of pollution into the river and Firm B will dump 10 tons of pollution into the river.
d. Firm A will increase its pollution and Firm B will reduce its pollution.
ANSWER: b. Firm B will no longer pollute and Firm A will not reduce its pollution at all.
TYPE: M SECTION: 3 DIFFICULTY: 3
206. Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped into the
river. The government will sell 40 pollution permits for $75 each. It costs Firm A $100 for each ton of pollution that it
eliminates before it reaches the river and it costs Firm B $50 for each ton of pollution that it eliminates before it
reaches the river. It is likely that between the cost of permits and the cost of additional pollution abatement,
a. Firm B will spend $3,500.
b. Firm A will spend $4,000.
c. Firm A will spend $4,500.
d. Firm B will spend $3,000.
ANSWER: b. Firm A will spend $4,000.
TYPE: M SECTION: 3 DIFFICULTY: 3
Chapter 10/Externalities 313
TRUE/FALSE
1. When a transaction between a buyer and seller directly affects a third party, the effect is called an externality.
ANSWER: T TYPE: T 2. In a market characterized by externalities, the market equilibrium fails to maximize the total
benefit to society as a whole.
ANSWER: T TYPE: T 3. Negative externalities lead markets to produce a smaller quantity of a good than is socially
desirable, while positive externalities lead markets to produce a larger quantity of a good than is socially desirable.
ANSWER: F TYPE: T 4. Barking dogs cannot be considered an externality because externalities must be associated with
some form of market exchange.
ANSWER: F TYPE: T 5. Organizers of an outdoor concert in a park surrounded by residential neighborhoods are likely
to consider the noise and traffic cost to residential neighborhoods when they assess the financial viability of the
concert venture.
ANSWER: F TYPE: T SECTION: 1
6. The social cost of pollution includes the private costs of the producers plus the costs to those bystanders affected
adversely by the pollution.
ANSWER: T TYPE: T SECTION: 1
8. Internalizing a negative externality will cause the market supply curve to shift to the left.
ANSWER: T TYPE: T SECTION: 1
9. The government can internalize an externality by taxing goods that have negative externalities and subsidizing
goods that have positive externalities.
ANSWER: T TYPE: T SECTION: 1
10. If the social cost of producing robots is less than the private cost of producing robots, the private market produces
too few robots.
ANSWER: T TYPE: T SECTION: 1
11. The patent system gives firms greater incentive to engage in research and other activities that advance technology.
ANSWER: T TYPE: T SECTION: 1
13. Government subsidized scholarships are an example of a government policy aimed at correcting for negative
externalities associated with education.
ANSWER: F TYPE: T SECTION: 1
14. According to the Coase theorem, if private parties can bargain without cost, then the private market will always
solve the problem of externalities.
ANSWER: T TYPE: T SECTION: 2
15. When people take into account how their actions affect others, the problem of externalities is solved.
ANSWER: T TYPE: T SECTION: 2
16. According to the Coase theorem, whatever the initial distribution of rights, the interested parties can reach a bargain
in which everyone is better off and the outcome is efficient.
ANSWER: T TYPE: T SECTION: 2
314 Chapter 10/Externalities
17. According to the Coase theorem, the private market will need government intervention in order to reach an efficient
outcome.
ANSWER: F TYPE: T SECTION: 2
18. Despite the appealing logic of the Coase theorem, private actors often fail to resolve the problems caused by
externalities on their own.
ANSWER: T TYPE: T SECTION: 2
19. Private parties may choose to leave an externality problem unsolved if the transaction costs are large enough.
ANSWER: T TYPE: T SECTION: 2
20. Government can be used to solve externality problems that are too costly for private parties to solve.
ANSWER: T TYPE: T SECTION: 2
21. Despite the stated goals of some environmentalists, it would be impossible to prohibit all polluting activity.
ANSWER: T TYPE: T SECTION: 3
22. When one business confers an externality on another business, the two businesses can internalize the externality by
merging.
ANSWER: T TYPE: T SECTION: 3
23. Most economists prefer regulation to taxation because regulation corrects market inefficiencies at a lower cost than
taxation does.
ANSWER: F TYPE: T SECTION: 3
24. When correcting for an externality, command-and-control policies are always preferable to market-based policies.
ANSWER: F TYPE: T SECTION: 3
25. In essence, the Pigovian tax places a price on the right to pollute.
ANSWER: T TYPE: T SECTION: 3
26. Equal reduction in pollution, among all firms, is the least expensive way to clean up the environment.
ANSWER: F TYPE: T SECTION: 3
27. Pigovian taxes enhance efficiency, but the cost to administer the tax frequently exceeds the revenue they raise for the
government.
ANSWER: F TYPE: T SECTION: 3
28. Social welfare can be enhanced by allowing firms to trade their rights to pollute.
ANSWER: T TYPE: T SECTION: 3
29. A market for pollution permits can efficiently allocate the right to pollute by the forces of supply and demand.
ANSWER: T TYPE: T SECTION: 3
30. Firms that can reduce pollution easily would be willing to sell their pollution permits.
ANSWER: T TYPE: T SECTION: 3
31. The Environmental Protection Agency (EPA) cannot reach a target level of pollution through the use of pollution
permits.
ANSWER: F TYPE: T SECTION: 3
32. Both pollution permits and Pigovian taxes are viewed as cost effective ways to keep the environment clean.
ANSWER: T TYPE: T SECTION: 3
33. Luckily, the free market corrects for the cost to bystanders of a crying child, because the parent is irritated as much if
not more than the bystander.
ANSWER: F TYPE: T SECTION: 3
Chapter 10/Externalities 315
SHORT ANSWER
2. Using a supply and demand diagram, demonstrate how a positive externality leads to market inefficiency. How
might the government help to eliminate this inefficiency?
ANSWER:
A positive externality leads the market to exchange a smaller quantity than is socially desirable. The government
could help eliminate this inefficiency by subsidizing the product.
TYPE: S SECTION: 1
3. Using a supply and demand diagram, demonstrate how a negative externality leads to market inefficiency. How
might the government help to eliminate this inefficiency?
ANSWER:
A negative externality leads the market to exchange a larger quantity than is socially desirable. The government
could help eliminate this inefficiency by taxing the product.
TYPE: S SECTION: 1
316 Chapter 10/Externalities
4. Graphically illustrate the quantity of pollution that would be emitted (a) after a Pigovian tax has been imposed and
then (b) after tradable pollution permits have been imposed. Could these two quantities ever be equivalent?
ANSWER:
Yes, these two quantities could be equal. (For instance, if PB is equal to the amount of the Pigovian tax.)
5. The Coase theorem suggests that efficient solutions to externalities can be arrived at through bargaining. Under
what circumstances does this fail to produce a solution?
ANSWER:
1. The existence of significant transactions costs.
2. Parties may try to hold out for a better deal, and thus the bargaining process breaks down.
3. The number of parties to a bargaining process is large.
TYPE: S SECTION: 2
6. To produce honey, beekeepers place hives of bees in the fields of farmers. As bees gather nectar, they pollinate the
crops in the fields increasing the yields of these fields at no additional cost to the farmer. What might be a reasonable
private solution to this externality and how might the solution be reached?
ANSWER: One solution would be to have the farmer also own the beehives. This internalizes the externality. Another
solution would be to have the farmer compensate the owner of the beehives for the value of the pollination. On the
other hand, the owner of the beehives prospers by locating his hives next to the farmer’s fields. She should be
willing to compensate the farmer for this benefit.
TYPE: S SECTION: 2
7. Why are public policy solutions such as Pigovian taxes and subsidies preferred over regulatory policies?
ANSWER: The preference for Pigovian taxes and subsidies is based on the ability of markets to signal optimal resource
allocation.
TYPE: S SECTION: 3