978-0077660772 Chapter 4 Solution Manual Part 1

Chapter 04 – Market Failures: Public Goods and Externalities

McConnell Brue Flynn 19e

DISCUSSION QUESTIONS

1. Explain the two causes of market failures. Given their definitions, could a market be affected

by both types of market failures simultaneously? LO1

Answer: A public good is one where consumption in non-rival and non-excludable.

Private goods are not profitable because of the free rider problem. If we want to set off

fireworks and charge for the event, we probably wouldn’t generate much revenue. We

Answer 1: Yes, it is possible for both to occur if an individual values the good, such as

Answer 2: No, because if the free-rider problem is present firms will not produce any of

2. Use the ideas of consumer surplus and producer surplus to explain why economists say

competitive markets are efficient. Why are below- or above-equilibrium levels of output

inefficient, according to these two sets of ideas? LO2

Answer: When the consumers’ utility exceeds the price paid, consumer surplus is

generated. Likewise, when producers receive a price greater than marginal cost, producer

3. What are the two characteristics of public goods? Explain the significance of each for public

provision as opposed to private provision. What is the free-rider problem as it relates to public

goods? Is U.S. border patrol a public good or a private good? Why? How about satellite TV?

Explain. LO3

Answer: Public goods are nonrival (one person’s consumption does not prevent

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Chapter 04 – Market Failures: Public Goods and Externalities

including free riders—can be excluded from the goods’ benefits). If goods are nonrival,

there is less incentive for private firms to produce them – those purchasing the good

4. What divergences arise between equilibrium output and efficient output when (a) negative

externalities and (b) positive externalities are present? How might government correct these

divergences? Cite an example (other than the text examples) of an external cost and an external

benefit. LO4

Answers:

(a) When negative externalities are present, the equilibrium output will be greater

(b) When positive externalities are present, the equilibrium output will be smaller

than the efficient output because the consumer is willing to pay a price equal

Government might correct external costs through regulation, which requires

firms to internalize these external costs, or it might tax the externality until it

Other examples of external costs might include secondhand smoke, noise

5. Why are spillover costs and spillover benefits also called negative and positive externalities?

Show graphically how a tax can correct for a negative externality and how a subsidy to producers

can correct for a positive externality. How does a subsidy to consumers differ from a subsidy to

producers in correcting for a positive externality? LO4

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Chapter 04 – Market Failures: Public Goods and Externalities

Answers: Spillover costs are called negative externalities because they are external to the

participants in the transaction and reduce the utility of affected third parties (thus

6. An apple grower’s orchard provides nectar to a neighbor’s bees, while the beekeeper’s bees

help the apple grower by pollinating his apple blossoms. Use Figure 4.6b to explain why this

situation of dual positive externalities might lead to an underallocation of resources to both apple

growing and beekeeping. How might this underallocation get resolved via the means suggested

by the Coase theorem? LO4

Answers: Using Figure 4.6b in the text the following can be said: The market demand

curves for apples and honey, Da and Dh, would not include the spillover benefits

Using the Coase theorem, we note that it will be to the advantage of individual

apple growers and beekeepers to negotiate so that beekeepers (whose hives can be

7. The LoJack car recovery system allows the police to track stolen cars. As a result, they not only

recover 90% of LoJack-equipped cars that are stolen but also arrest many auto thieves and shut

down many “chop shops” that take apart stolen vehicles to get at their used parts. Thus, LoJack

provides both private benefits and positive externalities. Should the government consider

subsidizing LoJack purchases? LO4

Answers: If the government were to subsidize LoJack purchases, this would reduce the

private cost of the anti-theft devices. This reduction in the private cost would, in-turn,

8. Explain why zoning laws, which allow certain land uses only in specific locations, might be

justified in dealing with a problem of negative externalities. Explain why in areas where buildings

sit close together tax breaks to property owners for installing extra fire prevention equipment

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Chapter 04 – Market Failures: Public Goods and Externalities

might be justified in view of positive externalities. Explain why excise taxes on beer might be

justified in dealing with a problem of external costs. LO5

Answers: Zoning could force businesses producing negative externalities to

locate in regions where these costs would not spill over onto third parties, or

where such costs would at least be reduced. Businesses wanting to locate in

9. LAST WORD Distinguish between a carbon-tax and a cap-and-trade strategy for reducing

carbon dioxide and other so-called greenhouse gases (that are believed by many scientists to be

causing global warming). Which of the two strategies do you think would have the most political

support in an election in your home state? Explain your thinking.

Answers: Scientific evidence suggests that carbon dioxide and other gas

emissions are accumulating and causing the average temperature of the

A carbon-tax affects each polluting firm by charging them for emissions. The cap-

REVIEW QUESTIONS

1. Draw a supply and demand graph and identify the areas of consumer surplus and producer

surplus. Given the demand curve, what impact will an increase in supply have on the amount of

consumer surplus shown in your diagram? Explain why. LO2

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Chapter 04 – Market Failures: Public Goods and Externalities

Answer: An increase in supply will lower the price and increase the amount of consumer

2. Assume that candle wax is traded in a perfectly competitive market in which the

demand curve captures buyers’ full willingness to pay while the supply curve reflects all

production costs. For each of the following situations, indicate whether the total output

should be increased, decreased, or kept the same in order to achieve allocative and

productive efficiency. LO2

a. The maximum willingness to pay exceeds minimum acceptable price.

b. Marginal Cost > Marginal Benefit.

c. Total surplus is at a maximum.

d. The current quantity produced exceeds the market equilibrium quantity.

Answer:

a. increased More candle wax should be produced and sold because doing so

would increase allocative efficiency and help to ensure that society’s limited

supply of resources are being used to produce the products that consumers most

b. decreased Output should be reduced in order to improve allocative efficiency.

Because MC > MB at the current level of production, we know that the cost of

producing the final unit of candle wax exceeds the benefit felt by consumers from

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Chapter 04 – Market Failures: Public Goods and Externalities

c. kept the same Production should be kept at the same level because the level of

output that maximizes total surplus is also the level of output that guarantees

allocative efficiency. The easiest way to see this is by nothing that both reducing

d. decreased The most amazing thing about equilibrium in competitive markets is

that when demand curves fully reflect buyers’ willingness to pay and supply

curves fully reflect all production costs, the market equilibrium quantity will be

3. Efficiency losses ____________________________. LO2

a. Are not possible if suppliers are willing to produce and sell a product.

b. Can only result from underproduction.

c. Can only result from overproduction.

d. None of the above.

Efficiency losses can result from either overproduction or underproduction. The

4. Draw a production possibilities curve with public goods on the vertical axis and private goods

on the horizontal axis. Assuming the economy is initially operating on the curve, indicate how the

production of public goods might be increased. How might the output of public goods be

increased if the economy is initially operating at a point inside the curve? LO3

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Chapter 04 – Market Failures: Public Goods and Externalities

Answer: On the curve, the only way to obtain more public goods is to reduce the

5. Use the distinction between the characteristics of private and public goods to determine

whether the following should be produced through the market system or provided by government:

(a) French fries, (b) court systems, (c) mail delivery, and (d) medical care. State why you

answered as you did in each case. LO3

Answer:

(a) French fries—market system (rival and excludable).

(b) Court systems—government (nonrival and nonexcludable).

6. Match each of the following characteristics or scenarios with either the term negative

externality or the term positive externality. LO4

a. Overallocation of resources.

b. Tammy installs a very nice front garden, raising the property values of all the other houses on

her block.

c. Market demand curves are too far to the left (too low).

d. Underallocation of resources.

e. Water pollution from a factory forces neighbors to buy water purifiers.

Answer:

a. negative externality Resources are overallocated to products that impose negative

externalities on third parties. This happens because the firms imposing negative

externalities on third parties fail to take into account the costs that would be needed to

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Chapter 04 – Market Failures: Public Goods and Externalities

b. positive externality Tammy’s garden provides a positive externality for her neighbors

c. positive externality Positive externalities cause market demand curves to be too far to

the left (too low) relative to total-benefit demand curves. The problem is that when there

d. positive externality Resources are underallocated to products that impose positive

externalities on third parties. The problem is that when there are positive externalities,

e. negative externality The factory’s water pollution imposes a negative externality on

7. Use marginal cost/marginal benefit analysis to determine if the following statement is true or

false: “The optimal amount of pollution abatement for some substances, say, dirty water from

storm drains, is very low; the optimal amount of abatement for other substances, say, cyanide

poison, is close to 100 percent.” LO5

Answer: Reducing water flow from storm drains has a low marginal benefit, meaning the

MB curve would be located far to the left of where it is in the text diagram. It will

PROBLEMS

1. Refer to Table 4.1. If the six people listed in the table are the only consumers in the market and

the equilibrium price is $11 (not the $8 shown), how much consumer surplus will the market

generate? LO2

Answer: $3

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Chapter 04 – Market Failures: Public Goods and Externalities

Feedback: Consider the following table as an example:

Using the values above, and assuming an equilibrium price of $11 (not the $8 shown), we

Bob’s consumer surplus is $2 (= $13 – $11)

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