Chapter 04 – Market Failures: Public Goods and Externalities
Chapter 04 – Market Failures: Public Goods and Externalities
McConnell Brue Flynn 21e
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
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
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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
consumption by another) and nonexcludable (once the goods are produced nobody—
including free riders—can be excluded from the goods’ benefits). If goods are nonrival,
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 than
(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 to the
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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
Answers: Spillover costs are called negative externalities because they are external to the
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
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
Chapter 04 – Market Failures: Public Goods and Externalities
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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
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
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.
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Answers: Scientific evidence suggests that carbon dioxide and other gas emissions are
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
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.
Chapter 04 – Market Failures: Public Goods and Externalities
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d. decreased The most amazing thing about equilibrium in competitive markets is
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.
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
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
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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.
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d. positive externality Resources are underallocated to products that impose positive
externalities on third parties. The problem is that when there are positive externalities,
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
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
Chapter 04 – Market Failures: Public Goods and Externalities
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Feedback: Consider the following table as an example:
Using the values above, and assuming an equilibrium price of $11 (not the $8 shown), we
2. Refer to Table 4.2. If the six people listed in the table are the only producers in the market and
the equilibrium price is $6 (not the $8 shown), how much producer surplus will the market
generate? LO2
Chapter 04 – Market Failures: Public Goods and Externalities
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Feedback: Consider the following table as an example:
Using the values above, and assuming an equilibrium price of $6 (not the $8 shown), we
3. Look at Tables 4.1 and 4.2 together. What is the total surplus if Bob buys a unit from Carlos? If
Barb buys a unit from Courtney? If Bob buys a unit from Chad? If you match up pairs of buyers
and sellers so as to maximize the total surplus of all transactions, what is the largest total surplus
that can be achieved? LO2