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21. The next three questions refer to the below supply and demand graph for a public good.
(a) What does point c represent?
(b) What does the line segment ef at output Q3 represent?
(c) At what output level is there an underallocation of resources to the production of this public good?
22. (Consider This) Discuss how technology has transitioned music to a public good. How can the music
industry remain profitable?
Music has transitioned from records, cassettes, and CDs to digital versions. When music came on records,
it was rival and excludable. If a popular artist released a new record it may be sell out on store shelves. The
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23. Imagine that a state government is considering the construction of a new state office building to consolidate
state operations. Its estimate of the total costs and the total benefits of building a 4- 6-, 8-, or 10-story
building is shown in the table below. (All figures are in millions of dollars.)
Project
Total
cost
Marginal
cost
Total
benefit
Marginal
benefit
No building
$ 0
$ 0
4-story building
7
$_____
8
$_____
6-story building
16
_____
23
_____
8-story building
24
_____
28
_____
10-story building
34
_____
31
_____
(a) Compute the marginal cost and the marginal benefit of the 4-, 6-, 8-, and 10-story buildings.
(b) Should the state build a new office building? If so, what size building and what will be the total
benefit, total cost, and net benefit to society?
(a) See table.
Project
Total
cost
Marginal
cost
Total
benefit
Marginal
benefit
No building
$ 0
$ 0
4-story building
7
$ 7
8
$ 8
6-story building
16
9
23
15
8-story building
24
8
28
5
10-story building
34
10
31
3
(b) Yes, the government should build a 6-story building. The total cost of building a 6-story building is
$16 million. The total benefit is $23 million. The net benefit is $7 million.
24. In the current presidential election, one candidate argues: “The government is extremely inefficient. To fix
this, government spending should be substantially reduced.” Evaluate this statement.
Efficiency in government is not dependent on the level of government spending. Rather, a government is
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25. Can economic analysis precisely determine the proper levels of government spending and taxation? In
your answer explain the problems in using cost-benefit analysis.
It is theoretically possible to determine the proper amount of government spending and the optimal quantity
of a public good. In theory, the demand for a public good can be found by adding the prices that people
collectively are willing to pay for the last unit of the public good at each particular quantity. Then, the
quantity and price at which the collective amount demanded matches the amount supplied will be the
equilibrium or “optimal” output level.
26. How do quasi-public goods differ from pure public goods? Give examples of both types. Explain the
rationale as to why quasi-public goods are often provided by government rather than private businesses.
A pure public good is characterized by nonrivalry and nonexcludability. The benefits are also not reduced
27. Describe the reallocation process of resources when the government provides more public or quasi-public
goods.
28. Define negative externality and give an example.
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29. Define positive externality and give an example.
30. Demand and supply curves for products for which there are negative or positive externalities are shown in
the three graphs below.
(a) On this graph draw in another curve that indicates what might happen after the producer was prevented
from causing a negative externality or was forced to pay a tax to cover these costs.
(b) On this graph draw in another curve that indicates the situation after the government subsidizes the
producer because there are positive externalities from this product.
(c) On this graph draw in another curve that indicates the situation after the government subsidizes
consumers for this product which has a positive externality.
31. What are negative externalities and positive externalities? How do they affect supply and demand curves?
Negative externalities result in an overallocation of resources to the production of a product. All the costs
Quantity
(a)
P
D
S
0
Quantity
(b)
P
D
S
0
Quantity
(c)
P
D
S
0
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32. (Consider This) How could you use the Coase theorem to predict what would happen when smoke from a
factory creates dirty air and slightly acid rain for all the residents in the area in a one-mile radius of the
plant?
Under the assumptions of the Coase theorem, either the property owners would have the rights to clean air
or the factory would have the property rights to pollute the air in that neighborhood. If the property owners
33. What is a Pigouvian Tax? Give an example of a good that the government may place this tax on.
34. How do direct controls and specific taxes affect externalities? Briefly explain in terms of supply and
demand.
Direct controls through laws or regulations that limit private activity are commonly used to curb private
activity that is deemed to cause negative externalities. In essence, direct controls either restrict production
35. What resource problem is created by negative externalities and what methods are suggested for dealing
with this problem?
36. What resource problem is created by positive externalities and what methods are suggested for dealing with
this problem?
When there are positive externalities from the production process, this causes an underallocation of
resources to the production of a product. The reason for the underallocation is that the firm is not receiving
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37. Explain the statement: “Clean air and water have become increasingly scarce and valuable resources
because they have been treated in the past as if they were free and unlimited in supply.” What methods
might be used to internalize spillover costs?
38. Suppose a local coffee shop in the downtown area decides to purchase a neighboring abandoned lot and
convert it into a garden area with outdoor seating.
(a) Does this decision create an externality? If so, what kind?
(b) Despite the city’s positive response to the coffee shop’s renovation, other businesses in the area have
not followed suit in renovating the many decrepit buildings and abandoned lots. How might the
presence of an externality be in part the cause of this?
(c) In response to the lack of effort on the part of businesses to renovate the downtown area, city council
members to take action. What are some ways that the city government could promote this kind of
revival?
39. Should all pollution be banned? Why might some level of pollution be economically efficient?
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40. The following table shows marginal costs and benefits of the optimal quantity of pollution abatement that
will occur at a local factory.
Quantity of pollution
abatement
Marginal
cost
Marginal
benefit
700 tons
$100,000
$ 20,000
600 tons
60,000
30,000
500 tons
40,000
40,000
400 tons
20,000
60,000
300 tons
10,000
80,000
200 tons
5,000
160,000
(a) What is the optimal level of pollution abatement? Why?
(b) If the marginal benefit of pollution abatement were to increase by $30,000 at each level because of the
factory’s desire to improve its image and environment, what would the optimal level be? Why?
(c) What might cause the optimal level of pollution abatement to be 400 tons?
41. The following table shows marginal costs and benefits of the optimal quantity of pollution abatement that
will occur at a local factory.
Quantity of pollution
abatement
Marginal
cost
Marginal
benefit
200 tons
$300,000
$ 20,000
180 tons
180,000
30,000
160 tons
120,000
40,000
140 tons
60,000
60,000
120 tons
30,000
80,000
100 tons
15,000
160,000
(a) What is the optimal level of pollution abatement? Why?
(b) If the marginal benefit of pollution abatement were to increase by $150,000 at each level because of
the factory’s desire to improve its image and environment, what would the optimal level be? Why?
(c) What might cause the optimal level of pollution abatement to be 120 tons?
42. “Pollution should be completely eliminated.” Evaluate. Support your answer using MB and MC analysis.
43. What perspective do economists use to evaluate the issue of the amount of pollution control?
44. What are the limitations to government’s role in the economy?
Although there are many roles for government to play in the economy, the task is not an easy one.
45. (Last Word) Describe the idea behind the cap-and-trade program for improving environmental quality.
Explain how supply and demand determine the price for pollution rights in this case.
46. (Last Word) Describe how a market for externality rights or cap-and-trade system would work in terms of
supply and demand.
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47. (Last Word) Assume the atmosphere of an urban area is able to reabsorb 4000 tons of pollutants per year.
The schedule below shows the price polluters would be willing to pay for the right to dispose of 1 ton of
pollutants per year and the total quantity of pollutants they would wish to dispose of at each price.
Price
(per ton of
pollutant rights)
Total quantity of pollutant
rights demanded
(tons)
$ 0
8000
1000
7000
2000
6000
3000
5000
4000
4000
5000
3000
6000
2000
7000
1000
(a) If there were no emission fee, how many tons of pollutants would there be and how much greater
would this amount be than the capacity for reabsorption?
(b) What pollution fee should the urban authorities charge to solve the problem?
(c) What would happen in this market for pollution rights if quantity demanded increased by 1000 tons at
each price?
48. (Last Word) Assume the atmosphere of an urban area is able to reabsorb 8000 tons of pollutants per year.
The schedule below shows the price polluters would be willing to pay for the right to dispose of 1 ton of
pollutants per year and the total quantity of pollutants they would wish to dispose of at each price.
Price
(per ton of
pollutant rights)
Total quantity of pollutant
rights demanded
(tons)
$ 0
13,000
1000
12,000
2000
11,000
3000
10,000
4000
9,000
5000
8,000
6000
7,000
7000
6,000
(a) If there were no emission fee, how many tons of pollutants would there be and how much greater
would this amount be than the capacity for reabsorption?
(b) What pollution fee should the urban authorities charge to solve the problem?
(c) What would happen in this market for pollution rights if quantity demanded increased by 1000 tons at
each price?
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49. (Last Word) Draw a supply and demand graph on the below diagram that illustrates the market for
pollution rights. Label the axes and curves. Then show what happens to price and quantity when the
demand for pollution rights increases in the market.
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C. Appendix Questions
50. What are information problems affecting sellers? Give an example that illustrates how these types of
51. Why would the establishment of a system of weights and measures and inspections by government help
52. What actions has government taken to improve buyer information in the market for surgery?
53. What is meant by the term “moral hazard”? What is an example of a moral hazard problem?
54. Examine how the invention of the seatbelt may have created a moral hazard problem.
55. What potential economic problem can arise with a guaranteed payment contract for professional athletes
that is not related to performance?
56. Examine the benefits and cons of employee pay in the form of salary and commission, or incentive pay, in
57. Explain the problem of adverse selection. How might this problem affect transactions in the insurance
industry?
58. Explain the problem of adverse selection. Discuss ways health insurance companies have tried to overcome
59. How have firms and organizations devised ways to overcome information problems without government
intervention? Give three examples.
D. Answers to Appendix Questions
50. What are information problems affecting sellers? Give an example that illustrates how these types of
problems are resolved.
Information problems arise when either buyers or sellers have incomplete or inaccurate information. For
51. Why would the establishment of a system of weights and measures and inspections by government help
market function? Discuss in terms of the market for gasoline.
52. What actions has government taken to improve buyer information in the market for surgery?
53. What is meant by the term “moral hazard”? What is an example of a moral hazard problem?
54. Examine how the invention of the seatbelt may have created a moral hazard problem.
55. What potential economic problem can arise with a guaranteed payment contract for professional athletes
that is not related to performance?
56. Examine the benefits and cons of employee pay in the form of salary and commission, or incentive pay, in
terms of the moral hazard problem.
57. Explain the problem of adverse selection. How might this problem affect transactions in the insurance
industry?
58. Explain the problem of adverse selection. Discuss ways health insurance companies have tried to overcome
this problem.
59. How have firms and organizations devised ways to overcome information problems without government
intervention? Give three examples.
