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Subjective Short Answer
1. Does research into new technologies create a positive externality or does it create a negative externality?
2. Does the phenomenon of externalities strengthen the argument that we should rely upon the “invisible hand” of the
marketplace, or does it weaken that argument?
3. Bruce engages in an activity that diminishes the well-being of Shawna. Bruce pays no compensation to Shawna for her
loss in well-being. What specific term do economists use to describe this situation?
4. Sheryl sits on her patio and plays her guitar while her neighbors are outside. Sheryl neither pays nor receives any
compensation for playing her guitar. Under what condition does her guitar-playing give rise to a positive externality?
5. Does the restoration of historic buildings create a positive externality or does it create a negative externality?
6. Briefly explain how research into new technologies gives rise to a positive externality.
7. At any given quantity, the willingness to pay of the marginal buyer is the height of the __________.
8. At any given quantity, the cost of the marginal seller is the height of the __________.
Scenario 10-2
The demand curve for restored historic buildings slopes downward and the supply curve for restored historic buildings
slopes upward. The production of the 50th restored historic building entails the following:
• a private cost of $800,000;
• a private value of $650,000;
• a social value of $800,000.
9. Refer to Scenario 10-2. Is there an externality associated with this market? If your answer is “Yes,” is the externality
positive or negative?
10. Refer to Scenario 10-2. Is there an external cost associated with the restoration of the 50th historic building, or is
there an external benefit? What is the amount of that external cost or external benefit?
11. Refer to Scenario 10-2. Is the market equilibrium quantity of restored historic buildings less than, equal to, or greater
than 50?
12. Refer to Scenario 10-2. Is the socially optimal quantity of restored historic buildings less than, equal to, or greater
than 50?
13. Refer to Scenario 10-2. Could the government impose a tax or provide a subsidy to move the market to the social
optimum? If your answer is “Yes,” should it be a tax or should it be a subsidy?
Scenario 10-3
Suppose the equation for the demand curve in a market is , where is the quantity demanded and is
the price. Also, suppose the equation for the supply curve in the same market is , where is the quantity
supplied.
14. Refer to Scenario 10-3. What are the market equilibrium quantity and price?
15. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What particular tax or subsidy would move the market to the social optimum?
16. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What is the equation of the social-cost curve?
17. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What is the social cost of producing 30 units of the good?
18. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What are the socially optimal quantity and price?
19. Suppose the market-equilibrium quantity of good x is larger than the socially-optimal quantity of good x. Does the
production of good x convey a positive externality or does it convey a negative externality?
20. Suppose the socially-optimal quantity of good x is larger than the market-equilibrium quantity of good x. Does the
production of good x convey a positive externality or does it convey a negative externality?
21. Suppose a tax is imposed on producers of aluminum as a means of internalizing the externality associated with
aluminum production. If the tax accurately reflects the external costs of pollutants released into the atmosphere, then the
new supply curve for aluminum coincides with which other curve?
22. Suppose a subsidy is offered to consumers of education as a means of internalizing the externalities associated with
education. If the subsidy accurately reflects the external benefits of education, then the new demand curve for education
coincides with which other curve?
23. Assume each gallon of gasoline that is produced gives rise to an external cost of $1.25. On any given day, the
production of the 10,000th gallon of gasoline entails a private value of $4.00 and a social cost of $3.50. What is the private
cost of the 10,000th gallon?
24. Assume each college degree that is granted conveys an external benefit of $3,500. The granting of the 500th college
degree entails a private cost of $15,000 and a private value of $25,000. What is the social value of the 500th college
degree?
Scenario 10-4
The demand curve for fire extinguishers slopes downward and the supply curve for fire extinguishers slopes upward. The
production of the 500th fire extinguisher entails the following:
• a private cost of $10;
• an external cost of $0;
• a private value of $9;
• an external benefit of $3.
25. Refer to Scenario 10-4. Does the production of fire extinguishers convey a positive externality, a negative externality,
or neither?
26. Refer to Scenario 10-4. What is the social value of the 500th fire extinguisher?
27. Refer to Scenario 10-4. In order to reach the social optimum, should fire extinguishers be taxed or subsidized? What
is the appropriate amount of the tax or subsidy on each fire extinguisher?
28. Refer to Scenario 10-4. Is the market-equilibrium quantity of fire extinguishers less than, equal to, or greater than
500? Explain.
29. Refer to Scenario 10-4. Is the socially-optimal quantity of fire extinguishers less than, equal to, or greater than 500?
Explain.
30. Refer to Scenario 10-4. In order to maximize the total benefit of fire extinguishers to society as a whole, should the
number of fire extinguishers produced be less than, equal to, or greater than 500? Explain.
31. When we identify public policies toward externalities, we contrast command-and-control policies with what other type
of policies?
32. Some policies toward externalities provide incentives so that private decision makers will choose to solve the problem
on their own. What name do we use for these types of policies?
33. As a means of dealing with pollution, do economists generally prefer corrective taxes or do they prefer regulations?
34. Suppose the Environmental Protection Agency issues pollution permits in order to limit the quantity of pollution.
Under this policy, is the supply of pollution rights perfectly elastic or is it perfectly inelastic?
35. What are the three externalities that are associated with driving cars and trucks?
36. A former senator remarked that “We cannot give anyone the option of polluting for a fee.” Do most economists agree
with this statement, or do they disagree with it?
37. Suppose a new market for tradable pollution permits is created. As long as there is a free market for the pollution
rights, the final allocation will be __________ , regardless of the initial allocation of permits.
38. Suppose the Environmental Protection Agency uses a corrective tax to set a price for pollution. Under this policy, is
the supply curve for pollution rights vertical or is it horizontal?
39. Some government policies provide incentives for private decision makers to choose to solve the problem of
externalities on their own. What term do we use to describe such policies?
40. Suppose a Pigovian tax is imposed on a market that is characterized by one or more externalities. Is this a command-
and-control policy or is it a market-based policy?
41. The Environmental Protection Agency (EPA) requires that firms in a certain industry adopt a particular technology to
reduce the emission of pollutants. Is this requirement a command- and-control policy or is it a market-based policy?
42. Describe the circumstances under which it would be better for the government to sell pollution permits than to levy a
corrective tax.
43. Suppose the government levies a corrective tax on firms that pollute in order to limit the quantity of pollution. Under
this policy, does the demand curve for pollution rights determine the quantity of pollution, or does it determine the price
of pollution?
44. Suppose the government issues a limited number of pollution permits in order to limit the quantity of pollution. Under
this policy, does the demand curve for pollution rights determine the quantity of pollution, or does it determine the price
of pollution?
45. The likelihood of successful private solutions to problems caused by externalities depends, in part, upon the number of
interested parties. Briefly explain.
46. Tyler owns a dog and receives a $300 benefit from owning it. Tyler’s neighbor, Liz, incurs a cost of $450 from the
dog’s barking. Suggest a deal between Tyler and Liz that would result in both individuals becoming better off.
47. Beverly owns a rabbit and receives a $600 benefit from owning it. Sometimes Beverly’s rabbit makes its way onto the
lawn of her neighbor, Charles, and eats the vegetables in Charles’ garden. This intrusion by the rabbit costs Charles $400.
Can both individuals become better off if Charles pays Beverly some amount of money to get rid of the rabbit? Explain.
48. An example of a private solution to externalities is charities. The government encourages this private solution by
allowing ___________ .
49. In some situations, private economic actors cannot solve the problem of externalities among themselves because of
substantial _________ costs.
50. Which theorem asserts that private economic actors can often solve the problem of externalities among themselves?
51. Using a supply and demand diagram, demonstrate how a negative externality leads to market inefficiency. How might
the government help to eliminate this inefficiency?
52. Using a supply and demand diagram, demonstrate how a positive externality leads to market inefficiency. How might
the government help to eliminate this inefficiency?
53. Why are Pigovian taxes preferred to regulatory policies as methods to remedy negative externalities?
54. Use a graph to illustrate the quantity of pollution that would be emitted (a) after a corrective tax has been imposed and
(b) after tradable pollution permits have been imposed. Could these two quantities ever be equivalent?
55. To produce honey, beekeepers place hives of bees in the fields of farmers. As bees gather nectar, they pollinate the
crops in the fields, which increases 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?
56. The Coase theorem suggests that efficient solutions to externalities can be determined through bargaining. Under what
circumstances will private bargaining fail to produce a solution?
