Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
190 ❖ Chapter 10/Externalities
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
pollution, issue permits for that amount, and allow the firms to trade the permits. This
reduces pollution while allowing economic efficiency.
3. Examples of private solutions to externalities include moral codes and social sanctions,
charities, and relying on the interested parties entering into contracts with one other.
The Coase theorem is 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.
Private economic participants are sometimes unable to solve the problems caused by an
externality because of transaction costs or because bargaining breaks down. This is most
likely when the number of interested parties is large.
Questions for Review
1. Examples of negative externalities include pollution, barking dogs, and consumption of
and positive externalities are possible.)
2. Figure 1 illustrates the effect of a negative externality. The equilibrium quantity provided by
quantity for society is
Q
optimum. The private market produces too much of the good because
Q
market is greater than
Q
optimum.
Figure 1
3. The patent system helps society solve the externality problem from technology spillovers. By
effects.
Chapter 10/Externalities ❖ 191
4. Corrective taxes are taxes enacted to correct the effects of a negative externality. Economists
determine the least expensive way to reduce pollution. The tax gives firms incentives to
5. Externalities can be solved without government intervention through moral codes and social
6. According to the Coase theorem, you and your roommate will bargain over whether your
your roommate smoking. The outcome is efficient as long as transaction costs do not prevent
Quick Check Multiple Choice
1. c
2. b
3. a
4. c
5. b
6. c
Problems and Applications
1. The Club conveys a negative externality on other car owners because car thieves will not
implications include a subsidy for car owners that use the Lojack technology or a tax on
those who use The Club.
2. a. Fire extinguishers exhibit positive externalities because even though people buy them for
their own use, they may prevent fire from damaging the property of others.
192 ❖ Chapter 10/Externalities
Figure 2
supply curve.
c. The market equilibrium level of output is denoted
Q
market and the efficient level of output
d. A government policy that would result in the efficient outcome would be to subsidize
people $10 for every fire extinguisher they buy. This would shift the demand curve up to
3. a. The extra traffic is a negative externality because the social cost is greater than the
private cost..
b. Figure 3 shows the market for theater tickets. Because there is no external benefit, the
intersect..
Figure 3
Demand
(social value)
Supply
social cost
Q
optimum
Q
market
$5
Quantity of Tickets
Price of Tickets
Chapter 10/Externalities ❖ 193
c. This is a positive externality because the social value of theater tickets is greater than the
private value in this case.
d. Figure 4 shows both the positive and the negative externalities.
Figure 4
4. a. The market for alcohol is shown in Figure 5. The social-value curve is the same as the
demand curve in this case. The social-cost curve is above the supply curve because of
output is
Q
optimum.
Figure 5
194 ❖ Chapter 10/Externalities
5. a. It is efficient to have different amounts of pollution reduction at different firms because
the costs of reducing pollution differ across firms. If all firms were made to reduce
b. Command-and-control approaches that rely on uniform pollution reduction among firms
give the firms no incentive to reduce pollution beyond the mandated amount. Instead,
c. Corrective taxes or tradable pollution rights give firms greater incentives to reduce
pollution. Firms are rewarded by paying lower taxes or spending less on permits if they
own.
6. a. At a price of $1.50, each Whovillian will consume 4 bottles of Zlurp. Each consumer’s
total willingness to pay is $14 (= $5 + $4 + $3 + $2). The total spent by each Whovillian
(=$14 − $6).
b. Total surplus would fall by $4 to $4.
d. The $1 tax raises the price of a bottle of Zlurp to $2.50. (The entire tax will be borne by
($12-$7.50) in consumer surplus.
Because each bottle has an external cost of $1, the per-resident external cost is $3 ($1
e. Yes, because total surplus is now higher than before the tax.
7. a. The externality is noise pollution. Ringo’s consumption of rock and roll music affects
Luciano, but Ringo does not consider that in deciding how loudly he plays his music.
c. Ringo and Luciano could negotiate an agreement that might, for example, allow Ringo to
play his music loudly at certain times of the day. They might not be able to reach an
for a better deal.
Chapter 10/Externalities ❖ 195
8. a. An improvement in the technology for controlling pollution would reduce the demand for
pollution rights, shifting the demand curve to the left. Figure 6 illustrates what would
demand for pollution rights and the curve labeled
D
2 is the new demand for pollution
rights after the improvement in technology.
Figure 6
Figure 7
9. a. In terms of economic efficiency in the market for pollution, it does not matter if the
government distributes the permits or auctions them off, as long as firms can sell the
permits to each other. The only difference would be that the government could make
money if it auctioned the permits off, thus allowing it to reduce taxes, which would help
196 ❖ Chapter 10/Externalities
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
reduce the deadweight loss from taxation. There could also be some deadweight loss
occurring if firms use resources to lobby for additional permits.
b. If the government allocated the permits to firms who did not value them as highly as
other firms, the firms could sell the permits to each other so they would end up in the
hands of the firms who value them most highly. Thus, the allocation of permits among
firms would not matter for efficiency. But it would affect the distribution of wealth,
10. a. The firms with the highest cost of reducing pollution will buy permits rather than reduce
their pollution. Firms that can sell their permits for more than it costs them to reduce
their pollution will sell.
Of the two remaining firms, firm A has the higher cost of reducing pollution so it will
keep its own 40 permits and reduce its pollution by 30 units at a cost of $20 x 30 units =
$600.
b. If the permits could not be traded, then firm A would have to reduce its pollution by 30
units at a cost of $20 × 30 = $600, firm B would have to reduce its pollution by 40 units
at a cost of $25 × 40 = $1,000, and firm C would have to reduce its pollution by 10 units
at a cost of $10 × 10 = $100. The total cost of pollution reduction would be $1,700,
