Chapter 18/Externalities, Commons, and Public Goods chapter 18 Externalities, Commons, and Public Goods
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Figure 18.4 
34) Figure 18.4 shows the payoff matrix for two firms. A chemical firm must choose between a low level of production which yields one ton of pollution into a nearby lake and a high level of production which yields two tons of pollution into the nearby lake. A private beach on the lake must decide whether to operate or not. Increased pollution reduces the number of people who wish to visit the beach. If nobody owns the lake, then A) the beach shuts down and the chemical firm produces 1 ton of pollution. B) the beach shuts down and the chemical firm produces 2 tons of pollution. C) the beach operates and the chemical firm produces 1 ton of pollution. D) the beach operates and the chemical firm produces 2 tons of pollution. Answer: D Diff: 2
Topic: Allocating Property Rights to Reduce Externalities 35) Figure 18.4 shows the payoff matrix for two firms. A chemical firm must choose between a low level of production which yields one ton of pollution into a nearby lake and a high level of production which yields two tons of pollution into the nearby lake. A private beach on the lake must decide whether to operate or not. Increased pollution reduces the number of people who wish to visit the beach. If the beach owner also owns the lake, and the chemical firm must pay $10 per ton to pollute, then A) the beach shuts down and the chemical firm produces 1 ton of pollution. B) the beach shuts down and the chemical firm produces 2 tons of pollution. C) the beach operates and the chemical firm produces 1 ton of pollution. D) the beach operates and the chemical firm produces 2 tons of pollution.
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Topic: Allocating Property Rights to Reduce Externalities 36) Figure 18.4 shows the payoff matrix for two firms. A chemical firm must choose between a low level of production which yields one ton of pollution into a nearby lake and a high level of production which yields two tons of pollution into the nearby lake. A private beach on the lake must decide whether to operate or not. Increased pollution reduces the number of people who wish to visit the beach. If the chemical firm owns the lake, and the beach owner must pay $10 to keep the chemical firm at just one ton of pollution, then A) the beach shuts down and the chemical firm produces 1 ton of pollution. B) the beach shuts down and the chemical firm produces 2 tons of pollution. C) the beach operates and the chemical firm produces 1 ton of pollution. D) the beach operates and the chemical firm produces 2 tons of pollution.
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Topic: Allocating Property Rights to Reduce Externalities 37) Figure 18.4 shows the payoff matrix for two firms. A chemical firm must choose between a low level of production which yields one ton of pollution into a nearby lake and a high level of production which yields two tons of pollution into the nearby lake. A private beach on the lake must decide whether to operate or not. Increased pollution reduces the number of people who wish to visit the beach. As long as someone owns the lake and the two parties can negotiate, then A) the beach shuts down and the chemical firm produces 1 ton of pollution. B) the beach shuts down and the chemical firm produces 2 tons of pollution. C) the beach operates and the chemical firm produces 1 ton of pollution. D) the beach operates and the chemical firm produces 2 tons of pollution.
Diff: 2
Topic: Allocating Property Rights to Reduce Externalities 38) Figure 18.4 shows the payoff matrix for two firms. A chemical firm must choose between a low level of production which yields one ton of pollution into a nearby lake and a high level of production which yields two tons of pollution into the nearby lake. A private beach on the lake must decide whether to operate or not. Increased pollution reduces the number of people who wish to visit the beach. Joint profits are maximized when A) the beach shuts down and the chemical firm produces 1 ton of pollution. B) the beach shuts down and the chemical firm produces 2 tons of pollution. C) the beach operates and the chemical firm produces 1 ton of pollution. D) the beach operates and the chemical firm produces 2 tons of pollution.
Diff: 2
Topic: Allocating Property Rights to Reduce Externalities 39) Figure 18.4 shows the payoff matrix for two firms. A chemical firm must choose between a low level of production which yields one ton of pollution into a nearby lake and a high level of production which yields two tons of pollution into the nearby lake. A private beach on the lake must decide whether to operate or not. Increased pollution reduces the number of people who wish to visit the beach. If nobody owns the lake, then A) joint profits are zero. B) joint profits are maximized. C) joint profits are not maximized. D) the beach will not operate because of too much pollution.
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Topic: Allocating Property Rights to Reduce Externalities 40) A common resource is best described as a resource where A) there is a positive externality in consumption. B) there is a negative externality in consumption. C) there is a positive externality in production. D) there is a negative externality in production.
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Topic: Common Property 41) To alleviate the commons problem, the government can apply a tax. set a quota. assign property rights. All of the above. Answer: D Diff: 0 Topic: Common Property 42) In the case of a good that has no exclusion and no rivalry, private markets fail because A) of free ridership. B) this is a natural monopoly. C) profit is driven down to zero. D) the quantity produced will exceed the social optimum.
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Topic: Public Goods 43) A public good in which exclusion is possible is called A) an exclusive good. B) a common good. C) an impure good. D) a club good.
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Topic: Public Goods 44) Markets tend to produce too little of an excludable public good because transaction costs are high. of the lack of rivalry. these goods are depletable. All of the above. Answer: B Diff: 1 Topic: Public Goods 45) The total demand for a public good is found by A) horizontally summing all individual demands. B) vertically summing all individual demands. C) finding the demand from the median voter. D) dividing the marginal cost of the good by the number of voters.
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Topic: Public Goods 46) The efficient quantity of a pure public good occurs when the marginal cost of producing that good equals the A) marginal benefit to the median voter. B) marginal benefit to each individual. C) sum of all individual marginal benefits. D) sum of all individual marginal benefits divided by the number of voters.
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Topic: Public Goods 47) When majority rule voting is used to determine whether to purchase a public good, A) the efficient outcome is not assured. B) the median voter gets her way. C) the sum of the marginal benefits is ignored. D) All of the above.
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Topic: Public Goods 48) When majority rule voting is used to determine whether to purchase a public good, A) the efficient outcome is assured. B) the median voter gets her way. C) the sum of the marginal benefits must equal marginal cost. D) the marginal benefit of the good to the median voter equals the good's marginal cost.
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Topic: Public Goods TRUE/FALSE/EXPLAIN 1) In the presence of a negative externality generated by producing a good, a competitive market will produce more of that good than is socially optimal. Answer: True. Firms in that market only consider their private costs and produce a quantity that equates price with the private marginal cost. Producers ignore the external costs to others. As a result, p = M Cp instead of p = M Cs. Diff: 0
Topic: The Inefficiency of Competition with Externalities 2) To maximize welfare in a competitive market that has a negative externality in production, government should tax a pollution-generating good at a specific tax equal to the marginal cost of producing the good. Answer: False. The tax should equal the marginal harm of the pollution at the socially optimal quantity of the good. Diff: 1
Topic: The Inefficiency of Competition with Externalities 3) Because a monopoly will produce less of a good than a competitive market will, welfare is always greater under monopoly than under competition in the presence of a negative externality. Answer: False. If monopoly produces more than the social optimum, then it does generate greater welfare than competition. If monopoly produces less than the social optimum, then it may or may not generate greater welfare. Diff: 2
Topic: Market Structure and Externalities 4) Firms that are most likely to buy marketable pollution rights are those that produce the most pollution per unit of output produced. Answer: False. Firms that will buy pollution rights are those whose products are worth a lot relative to the harm from pollution they create. Diff: 2
Topic: Allocating Property Rights to Reduce Externalities 5) The efficient quantity of a public good occurs when the marginal cost of providing that good equals the sum of the marginal benefits to all individuals. Answer: True. The demand for the public good is found by vertically summing so that we have the sum of the marginal benefits at each quantity. Diff: 2
Topic: Public Goods PROBLEMS 1) Suppose that in the market for paper, demand is p = 100 - Q. The private marginal cost is MCp = 10 + Q. Pollution generated during the production process creates external marginal harm equal to MCe = Q. What specific tax would result in a competitive market producing the socially optimal quantity of paper? Answer: The socially optimal quantity of paper is found by setting MCp+ MCe = p or 10 + Q + Q = 100 - Q. Rearranging yields Q = 30. At this level of output society incurs an external cost of 30. This is the specific tax that would yield the socially optimal quantity. To check set MCp + tax = 100 - Q. This yields Q = 30. Diff: 1
Topic: The Inefficiency of Competition with Externalities 2) Suppose that in the market for paper, demand is p = 100 - Q. The private marginal cost is MCp = 10 + Q. Pollution generated during the production process creates external marginal harm equal to MCe = Q. Is social welfare greater under monopoly or under competition? Answer: First, the socially optimal quantity of paper is found by setting MCp + MCe = p or 10 + Q + Q = 100 - Q. Rearranging yields Q = 30. The competitive equilibrium is found by setting MCp = p or 10 + Q = 100 - Q. Rearranging yields Q = 45. The deadweight loss of those additional units equals (45 - 30) * 45/2 = 337.50. Under monopoly, the firm sets MCp = 100 - 2Q or Q = 30. The monopoly produces the socially optimal quantity, and therefore has no deadweight loss. Social welfare is greater under monopoly. Diff: 1
Topic: The Inefficiency of Competition with Externalities Figure 18.1 
3) Suppose that the market for steel is shown in Figure 18.1. What specific tax would result in a competitive market producing the socially optimal quantity of steel? Answer: The social optimum occurs when 50 ingots are produced. At this level, the marginal external cost is $50. Thus, a specific tax of $50 will yield the socially optimal quantity. Diff: 1
Topic: The Inefficiency of Competition with Externalities 4) In terms of cost-benefit analysis, explain why a competitive market produces too much pollution. Answer: At the socially optimal level of production, welfare is maximized and the marginal benefit from less pollution equals the marginal cost of less output. However, a competitive market produces more pollution than is socially optimal, and the marginal cost of less output is greater than the marginal benefit from less pollution. Diff: 1
Topic: The Inefficiency of Competition with Externalities 5) Suppose that the market for steel is shown in Figure 18.1. Is social welfare greater under monopoly or under competition? Answer: Under competition, the deadweight loss equals area C. To find the monopoly outcome, draw the MR curve for the monopoly that has the same vertical intercept as the demand curve but is twice as steep. Where MR = M Cp determines the level of output the monopoly produces. This output is greater than 50 but less than 100. Social welfare is therefore greater under monopoly, since the monopoly quantity is closer to the socially optimal quantity than the competitive quantity. Diff: 2
Topic: Market Structures and Externalities 6) Explain how a specific tax equal to the marginal harm of pollution can increase or decrease total welfare in a monopoly market. Answer: If the monopoly is producing more output and pollution than the social optimum, then a specific tax equal to the marginal harm of pollution will increase total welfare. However, a monopoly may produce less output and thus pollution than is socially optimal. If this is the case, then a tax will decrease output more and lower welfare. Diff: 1
Topic: Market Structures and Externalities 7) A firm operates and produces pollution that only harms an individual, Bob. The firm and Bob both know the costs and benefits of reducing pollution. Neither the firm nor Bob acts strategically while bargaining, and there are no transaction costs associated with bargaining. Explain how the efficient level of pollution occurs no matter whether the firm or Bob owns the property right to pollution. Answer: If the firm has the right to pollute, then Bob can bargain with the firm. Bob will pay the firm up to the point where his per unit payment to reduce the pollution equals the marginal benefit he receives from pollution. This will be the efficient level of pollution. If Bob has the right to have no pollution, then the firm will pay to pollute until this cost equals the marginal benefit of a unit of production. This will result in the efficient level of pollution. Thus, no matter which party owns the property right, the efficient level of pollution will result. Diff: 1
Topic: Allocating Property Rights to Reduce Externalities Figure 18.3 
8) Figure 18.3 shows the marginal benefit from pollution for two firms. If both firms receive a marketable permit to pollute 25 units of pollution each, how much will each firm pollute and how much will a permit for one unit of pollution be worth? Answer: Firm B will sell permits to firm A until the marginal benefits are the same for both firms. Firm A will generate 37 tons of pollution and firm B will generate 13 tons of pollution. The market value of a permit will be $5. Diff: 2
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