Chapter 10/Externalities ❖ 61
Figure 10-16
77. Refer to Figure 10-16. This graph shows the market for pollution when permits are issued to firms and traded
in the marketplace. The equilibrium price of pollution is
a.
$50
b.
$500
c.
$1,000
d.
$2,000
78. Refer to Figure 10-16. This graph shows the market for pollution when permits are issued to firms and traded
in the marketplace. The equilibrium number of permits is
a.
50
b.
100
c.
1,000
d.
2,000
79. Refer to Figure 10-16. This graph shows the market for pollution when permits are issued to firms and traded
in the marketplace. In the absence of a pollution permit system, the quantity of pollution would be
a.
25
b.
50
c.
75
d.
100
80. Two firms, A and B, each currently emit 100 tons of chemicals into the air. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution emitted into the
air. The government gives each firm 40 pollution permits, which it can either use or sell to the other firm. It
costs Firm A $200 for each ton of pollution that it eliminates before it is emitted into the air, and it costs Firm
62 ❖ Chapter 10/Externalities
B $100 for each ton of pollution that it eliminates before it is emitted into the air. After the two firms buy or
sell pollution permits from each other, we would expect that Firm A will emit
a.
20 fewer tons of pollution into the air, and Firm B will emit 100 fewer tons of pollution into the air.
b.
100 fewer tons of pollution into the air, and Firm B will emit 20 fewer tons of pollution into the air.
c.
50 fewer tons of pollution into the air, and Firm B will emit 50 fewer tons of pollution into the air.
d.
20 more tons of pollution into the air, and Firm B will emit 100 fewer tons of pollution into the air.
81. Two firms, A and B, each currently emit 100 tons of chemicals into the air. The government has decided to
reduce the pollution and from now on will require a pollution permit for each ton of pollution emitted into the
air. The government gives each firm 40 pollution permits, which it can either use or sell to the other firm. It
costs Firm A $200 for each ton of pollution that it eliminates before it is emitted into the air, and it costs Firm
B $100 for each ton of pollution that it eliminates before it is emitted into the air. It is likely that
a.
Firm A will buy all of Firm B’s pollution permits. Each one will cost between $100 and $200.
b.
Firm B will buy all of Firm A’s pollution permits. Each one will cost between $100 and $200.
c.
Both firms will use their own pollution permits.
d.
Firm A will buy some of Firm B’s pollution permits. Each one will cost less than $100.
82. Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has de-
cided 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; $3,500
c.
$4,500; $4,000
d.
$4,500; $2,500
83. Two firms, A and B, each currently dump 20 tons of chemicals into the local river. The government has de-
cided 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.
84. Two firms, A and B, each currently dump 50 tons of chemicals into the local river. The government has de-
cided to reduce the pollution and from now on will require a pollution permit for each ton of pollution dumped
Chapter 10/Externalities ❖ 63
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. Neither firm produces any less output, but they both conform to the law.
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.
85. Which of the following require firms to pay to pollute?
(i)
corrective taxes
(ii)
tradable pollution permits
(iii)
pollution regulations
a.
(i) only
b.
both (i) and (ii)
c.
(iii) only
d.
both (ii) and (iii)
Figure 10-17
86. Refer to Figure 10-17. How large would a corrective tax need to be to move this market from the equilibrium
outcome to the socially-optimal outcome?
a.
An amount equal to P’ minus P.
b.
An amount equal to P’.
c.
An amount equal to P.
d.
An amount equal to the external cost.
P
P’
QQ’
D
S
External Cost
S’
Quantity
Price
64 ❖ Chapter 10/Externalities
Table 10-5
The following table shows the marginal costs for each of four firms (A, B, C, and D) to eliminate units of
pollution from their production processes. For example, for Firm A to eliminate one unit of pollution, it would
cost $54, and for Firm A to eliminate a second unit of pollution it would cost an additional $67.
Firm
Unit to be eliminated
B
C
D
First unit
57
54
62
Second unit
68
66
73
Third unit
86
82
91
Fourth unit
108
107
111
87. Refer to Table 10–5. If the government charged a fee of $69 per unit of pollution, how many
units of pollution would the firms eliminate altogether?
a.
7
b.
8
c.
9
d.
10
88. Refer to Table 10–5. If the government charged a fee of $84 per unit of pollution, how many units of pollu-
tion would the firms eliminate altogether?
a.
7
b.
8
c.
9
d.
10
89. Refer to Table 10–5. If the government wanted to reduce pollution from 16 units to 6 units, which of the fol-
lowing fees per unit of pollution would achieve that goal?
a.
$67
b.
$68
c.
$81
d.
$83
90. Refer to Table 10–5. If the government wanted to eliminate exactly 11 units of pollution, which of the fol-
lowing fees per unit of pollution would achieve that goal?
a.
$75
b.
$87
c.
$90
d.
$106
Chapter 10/Externalities ❖ 65
91. Refer to Table 10–5. Suppose the government wants to reduce pollution from 16 units to 8 units and auctions
off 8 pollution permits to achieve this goal. Which of the following is a likely auction price of the permits?
a.
$69
b.
$81
c.
$83
d.
$97
Table 10-6
The following table shows the total costs for each of four firms (A, B, C, and D) to eliminate units of pollution
from their production processes. For example, for Firm A to eliminate one unit of pollution, it would cost $46,
and for Firm A to eliminate two units of pollution, it would cost a total of $103.
Firm
Unit to be eliminated
B
C
D
One unit
45
42
49
Two units
100
98
108
Three units
173
169
183
Four units
263
264
280
92. Refer to Table 10–6. If the government charged a fee of $93 per unit of pollution, how many units of pollu-
tion would the firms eliminate altogether?
a.
5
b.
8
c.
11
d.
13
93. Refer to Table 10–6. If the government charged a fee of $99 per unit of pollution, how many units of pollu-
tion would the firms eliminate altogether?
a.
9
b.
12
c.
15
d.
16
94. Refer to Table 10–6. Suppose the government wanted to reduce pollution from 16 units to exactly 8 units.
Which of the following fees per unit of pollution would achieve that goal?
a.
$58
b.
$65
c.
$78
d.
$95
66 ❖ Chapter 10/Externalities
95. Refer to Table 10–6. Suppose there is presently no pollution fee, and the government wishes to eliminate ex-
actly 11 units of pollution. Which of the following fees per unit of pollution would achieve that goal?
a.
$60
b.
$70
c.
$76
d.
$88
96. Which of the following is not a negative externality associated with driving cars?
a.
congestion
b.
pollution
c.
repairs
d.
accidents
97. In summarizing the research on the externalities associated with driving cars, a 2007 Journal of Economic Lit-
erature article concluded that the optimal corrective tax on gasoline in the United States would be
a.
$0.40 per gallon.
b.
$0.90 per gallon.
c.
$2.10 per gallon.
d.
$3.30 per gallon.
98. Which of the following policies is not an example of a command-and-control policy?
a.
subsidies
b.
Pigovian taxes
c.
tradable pollution permits
d.
None of the above is an example of a command-and-control policy.
99. Which of the following statements is true of both pollution permits and corrective taxes?
a.
Both policies internalize the externality of pollution.
b.
Both policies require firms to pay for their pollution.
c.
Both policies lead to the establishment of an equilibrium price of pollution.
d.
All of the above are correct.
Chapter 10/Externalities ❖ 67
Figure 10-18. The graph represents a corrective tax to reduce pollution. On the axes, Q denotes the quantity
of pollution and P represents the price of pollution.
100. Refer to Figure 10-18. What is the appropriate label for the downward-sloping line on the graph?
a.
“Demand for clean air”
b.
“Demand for pollution rights”
c.
“Supply of pollution permits”
d.
“Tax paid to government”
101. Refer to Figure 10-18. The tax depicted on the graph
a.
gives polluting firms an incentive to develop cleaner technologies.
b.
is viewed by most economists as less effective than a command–and-control policy as a means of
reducing pollution.
c.
has the effect of moving the allocation of resources further from the social optimum than it would
be in the absence of the tax.
d.
All of the above are correct.
102. The business activities of Firm A confer positive externalities on Firm B, and the business activities of Firm B
confer positive externalities on Firm A. If the two firms merged, then
a.
their respective markets would move closer to the social optimum.
b.
their respective markets would move further away from the social optimum.
c.
total surplus in their respective markets would decrease.
d.
the merger would serve as an example of a misguided public policy toward externalities.
103. The tax on gasoline
a.
reduces efficiency by causing large deadweight losses.
b.
reduces efficiency by decreasing consumer surplus and producer surplus.
c.
enhances efficiency by serving as a corrective device in a market with positive externalities.
d.
enhances efficiency by serving as a corrective device in a market with negative externalities.
Corrective tax
Q
Q
P
68 ❖ Chapter 10/Externalities
104. Which of the following policies is an example of a command-and-control policy?
a.
subsidies to education
b.
maximum levels of pollution that factories may emit
c.
tradable pollution permits
d.
None of the above is an example of a command-and-control policy.
105. Which of the following statements is correct about a market in which pollution is emitted?
a.
Both corrective taxes and pollution permits internalize the externality of pollution.
b.
Corrective taxes internalize the externality of pollution, but pollution permits do not internalize that
externality.
c.
Corrective taxes fail to internalize the externality of pollution, but corrective taxes internalize that
externality.
d.
Neither corrective taxes nor pollution permits internalize the externality of pollution.
106. Which of the following statements is correct about a market in which pollution is emitted?
a.
Both corrective taxes and pollution permits move the market toward the social optimum.
b.
Corrective taxes move the market toward the social optimum, but pollution permits do not move the
market toward the social optimum.
c.
Pollution permits move the market toward the social optimum, but corrective taxes do not move the
market toward the social optimum.
d.
Neither corrective taxes nor pollution permits move the market toward the social optimum.
Chapter 10/Externalities ❖ 69
Figure 10-19
107. Refer to Figure 10-19. Which of the following quantities decreases as the quantity of the good is increased?
a.
the private cost of the good
b.
the social cost of the good
c.
the private value of the good
d.
the external benefit of the good
108. Refer to Figure 10-19. Each additional unit of the good that is produced yields an external
a.
benefit of $15.
b.
benefit of $36.
c.
cost of $15.
d.
cost of $36.
109. Refer to Figure 10-19. Each additional unit of the good that is produced yields an external benefit of
a.
$15.
b.
$23.
c.
$36.
d.
$89.
110. Refer to Figure 10-19. Note that the lines labeled “Demand” and “Social Value”are parallel. Also, the slopes
of the lines on the graph reflect the following facts: (1) Private value and social value decrease by $1.00 with
each additional unit of the good that is consumed, and (2) private cost increases by $1.40 with each additional
Supply
Social value
Demand
58 73
$89
$110
$125
94
Quantity
Price
70 ❖ Chapter 10/Externalities
unit of the good that is produced. Thus, when the 59th unit of the good is produced and consumed, social
well-being increases by
a.
$28.00.
b.
$31.40.
c.
$33.60.
d.
$36.00.
111. Refer to Figure 10-19. Note that the lines labeled “Demand” and “Social Value”are parallel. Also, the slopes
of the lines on the graph reflect the following facts: (1) Private value and social value decrease by $1.00 with
each additional unit of the good that is consumed, and (2) private cost increases by $1.40 with each additional
unit of the good that is produced. Thus, when the 74th unit of the good is produced and consumed, social
well-being
a.
decreases by $2.40.
b.
decreases by $1.60.
c.
increases by $1.00.
d.
increases by $1.40.
112. Refer to Figure 10-19. The socially optimal quantity of output is
a.
58 units.
b.
73 units.
c.
between 73 and 94 units.
d.
94 units.
113. Refer to Figure 10-19. How many units of the good are produced in a market equilibrium?
a.
fewer than 58
b.
58
c.
73
d.
94
114. Refer to Figure 10–19. The social optimum can be reached if
a.
a subsidy of $36 is applied to each unit of the good.
b.
a subsidy of $23 is applied to each unit of the good.
c.
a tax of $23 is applied to each unit of the good.
d.
a tax of $15 is applied to each unit of the good.
Chapter 10/Externalities ❖ 71
115. When he was a candidate for president, Barack Obama proposed which of the following as a means of com-
bating climate change?
a.
a “cap and trade” system in which the government would give away permits to emit carbon
b.
a “cap and trade” system in which the government would auction permits to emit carbon
c.
a tax on carbon emissions
d.
a government mandate to switch from gasoline-powered vehicles to vehicles powered by natural
gas
116. Writing in the New York Times in August 2009, N. Gregory Mankiw asserted that the remedy for climate
change that is overwhelmingly supported by economists is
a.
a “cap and trade” system in which the government would give away permits to emit carbon.
b.
an expansion of regulations on carbon emissions.
c.
stricter enforcement of existing regulations on carbon emissions.
d.
a tax on carbon emissions.
117. Writing in the New York Times in August 2009, N. Gregory Mankiw asserted that the particular “cap and
trade” legislation that was making its way to President Obama’s desk at that time would result in
a.
reduced purchasing power for Americans.
b.
reduced work incentives.
c.
depressed economic activity.
d.
All of the above are correct.
1. Externalities can be corrected by each of the following except
a.
self-interest.
b.
moral codes and social sanctions.
c.
charity.
d.
normal market adjustments.
2. The Golden Rule is an example of a private solution for
a.
subsidizing higher education.
b.
internalizing externalities.
c.
increasing production.
d.
reducing scarcity.
72 ❖ Chapter 10/Externalities
3. Two types of private solutions to the problem of externalities are
a.
charities and the Golden Rule.
b.
charities and subsidies.
c.
the Golden Rule and taxes.
d.
taxes and subsidies.
4. When externalities cause markets to be inefficient,
a.
government action is always needed to solve the problem.
b.
private solutions can be developed to solve the problem.
c.
given enough time, externalities can be solved through normal market adjustments.
d.
there is no way to eliminate the problem of externalities in a market.
5. Honey producers provide a positive externality to orchards because
a.
the honey producers get more honey.
b.
the orchard owner frequently gets stung by the honey producer’s bees.
c.
the orchard owner does not have to purchase bees to pollinate his flowers.
d.
the honey producers have to rent access to the orchard grounds.
6. 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 correct for negative externalities.
7. Firms that are involved in more than one type 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 regulations on their business.
d.
increase the private marginal cost of production.
8. Private contracts between parties with mutual interests
a.
will reduce the well-being of society.
b.
will lead to market outcomes in which the public interest is sacrificed for personal gain.
c.
can solve some inefficiencies associated with positive externalities.
d.
will create negative externalities.
Chapter 10/Externalities ❖ 73
9. Which of the following statements is not correct?
a.
Private markets tend to over-produce products with negative externalities.
b.
Private markets tend to under-produce products with positive externalities.
c.
Private parties can bargain to efficient outcomes even in the presence of externalities.
d.
Private parties are usually more successful in achieving efficient outcomes than government
policies.
10. Private solutions may not be possible due to the costs of negotiating and enforcing these solutions. Such costs
are called
a.
transaction costs.
b.
corrective costs.
c.
input costs.
d.
private costs.
11. 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.
12. The proposition that if private parties can bargain without cost over the allocation of resources, they can solve
the problem of externalities on their own, is called
a.
the Pigovian theorem.
b.
a corrective tax.
c.
the externality theorem.
d.
the Coase theorem.
13. Which of the following suggests that private markets 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
14. The Coase theorem suggests that private markets may not be able to solve the problem of externalities
a.
if the government does not become involved in the process.
b.
when the number of interested parties is large and bargaining costs are high.
c.
if the firm in the market is a monopoly.
d.
if some people benefit from the externality.
74 ❖ Chapter 10/Externalities
15. Transaction costs
a.
can keep private parties from solving externality problems.
b.
are incurred in the production process due to externalities.
c.
increase when taxes are imposed to correct negative externalities.
d.
are eliminated when the government intervenes in a market with externalities.
16. One reason that private solutions to externalities do not always work is that
a.
government intervention negates the benefits of positive externalities.
b.
some people benefit from externalities.
c.
interested parties incur costs in the bargaining process.
d.
charities are not well organized.
17. Assuming transaction costs are small, the Coase theorem would predict that private parties could arrive at an
efficient solution for which of the following problems?
a.
One neighbor lets his dog run through another neighbor’s garden, damaging her flowers.
b.
One neighbor doesn’t mow her yard.
c.
One neighbor plays his music loudly.
d.
All of the above are correct.
18. If only a few people are affected by an externality, then it is likely that
a.
corrective 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.
19. Reaching an efficient bargain is difficult when the
a.
externality is large.
b.
number of interested parties is large.
c.
externality is negative.
d.
government becomes involved.
20. Which of the following is a problem that keeps people from privately solving externality problems?
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.
Chapter 10/Externalities ❖ 75
21. 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.
maximize attorney fees.
b.
reduce the incentive of attorneys to file class action lawsuits.
c.
reduce the transaction costs of finding a private solution to an externality.
d.
regulate attorney fees.
22. 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.
an improper allocation of resources.
c.
a private solution to a negative externality problem.
d.
an exploitation of a common resource.
23. The Coase theorem suggests that private solutions to an externality problem
a.
are effective under all conditions.
b.
will usually allocate resources efficiently if private parties can bargain without cost.
c.
are only efficient when there are negative externalities.
d.
may not be possible because of the distribution of property rights.
24. In which of the following cases is the Coase theorem most likely to solve the externality?
a.
Ed is allergic to his roommate’s cat.
b.
Chemicals from manufacturing plants in the Midwest are causing acid rain in Canada.
c.
Polluted water runoff from farms is making residents of a nearby town sick.
d.
Industrialization around the world is causing global warming.
25. 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 legal 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.
26. According to the Coase theorem, private markets will solve externality problems and allocate resources effi-
ciently as long as
a.
the externalities that are present are positive, not negative.
b.
government assigns property rights to the harmed party.
c.
private parties can bargain with sufficiently low transaction costs.
d.
businesses determine an appropriate level of production.