CHAPTER 17
EXTERNALITIES AND THE ENVIRONMENT
In this chapter, you will find:
Learning Outcomes
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Solutions to Problems Appendix
Experiential Assignments
INTRODUCTION
A large portion of this chapter is devoted to problems of resource allocation when property rights are absent.
The result is that such resources tend to be over utilized. A pervasive example of this is the common–pool
LEARNING OUTCOMES
17-1 Describe the common pool problem and summarize ways to address it.
An exhaustible resource is available in fixed supply, such as crude oil or coal. A renewable
17-2 Determine the optimal level of pollution with fixed technology and with
variable technology. The optimal amount of environmental quality occurs where the marginal
social benefit of an improvement equals its marginal social cost. An upward shift of the marginal
benefit curve of environmental quality or a downward shift of its marginal cost curve increases the
17-3 Summarize how the federal government has regulated air, water, and land
pollution.
Federal efforts to address the common-pool problems of air, water, and soil pollution are coordinated
by the Environmental Protection Agency (EPA). According to EPA estimates, compliance with pollu-
17-4 Outline government policies designed to promote the production and
Chapter 17 Externalities and the Environment 234
consumption of goods that generate positive externalities. Positive externalities occur when consump-
tion or production benefits other consumers or other firms. When there are positive externalities, pub-
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-5 FOR THE FOLLOWING SECTION
Externalities and the Common-Pool Problem
• Exhaustible resource: A resource available in a finite amount, such as crude oil or copper ore.
• Renewable Resources: A resource that can be drawn on indefinitely if used conservatively.
USE POWERPOINT SLIDES 6-14 FOR THE FOLLOWING SECTION
Optimal Level of Pollution
External Costs with Fixed Technology
• Fixed-production technology: The relationship between output rate and the generation of an
externality is fixed.
USE POWERPOINT SLIDES 15-18 FOR THE FOLLOWING SECTION
The Coase Theorem: As long as bargaining costs are small, merely assigning the property right will
generate an efficient solution to an externality problem regardless of which party is assigned that right.
Markets for Pollution Rights: A system of marketable pollution rights can reduce the cost of pollution
abatement.
USE POWERPOINT SLIDES 19-26 FOR THE FOLLOWING SECTION
Environmental Protection: Federal efforts to address the common-pool problem of air, water, and
soil pollution are coordinated by the Environmental Protection Agency (EPA).
USE POWERPOINT SLIDES 27-30 FOR THE FOLLOWING SECTION
Chapter 17 Externalities and the Environment 235
Hazardous Waste and the Superfund: Chemicals can pose a risk at every stage of their production, use,
USE POWERPOINT SLIDES 31-34 FOR THE FOLLOWING SECTION
Positive Externalities: Occur when consumption or production benefits other consumers or other
firms.
CHAPTER SUMMARY
An exhaustible resource is available in fixed supply, such as crude oil or coal. A renewable resource can
regenerate itself if used conservatively, such as a properly managed forest. Some resources suffer from a
common-pool problem because unrestricted access leads to overuse.
The world’s tropical rainforests recycle greenhouse gases into oxygen and wood. Because rainforests are
open-access resources, settlers and loggers cut them down to make a living. This destruction reduces the
environment’s ability to cleanse itself of greenhouse gases, which contribute to global warming.
Chapter 17 Externalities and the Environment 236
TEACHING POINTS
1. A review of exhaustible and renewable resources is recommended to establish a foundation for
identification of what an externality is and is not. The key factor is that some benefit or cost associat-
2. Externalities are typically the consequences of nonexistent or unenforceable property rights. One of
the easiest ways to understand is the common–pool resource, which is a resource that belongs to eve-
rybody and therefore is free to all. Such common– pool resources—such as fish, ocean minerals, and
3. To determine the “cost” of an uncorrected externality, the class needs to be able to determine the
economically efficient level of the externality-producing activity. This is done by vertically adding
private and external costs (or benefits) to find the point at which marginal social benefits equal mar-
4. Another interesting idea developed in this chapter is the Coase theorem. It states that if property
rights can be assigned (and enforced), who, in fact, obtains the property rights is of no importance
in determining the economically efficient level of the externality-producing activity. In other words,
SOLUTIONS TO PROBLEMS APPENDIX
1. (Externalities) Complete each of the following sentences:
a. Resources for which periodic use can be continued indefinitely are known as _______
resources.
b. Resources that are available only in a fixed amount are_______ resources.
c. The possibility that an open-access resource is used until the net marginal value of
additional use equals zero is known as the_______.
a. renewable
Chapter 17 Externalities and the Environment 237
2. (Resolving the Common-Pool Problem) Why have authorities found it so difficult to regulate
the fishing catch in the open ocean to allow for a sustainable yield?
Fish represent a common-pool resource because no technology is available for establish-
3. (Negative Externalities) Suppose you wish to reduce a negative externality by imposing a tax on
the activity that creates that externality. When the amount of the externality produced per unit of
output increases as output increases, the correct tax can be determined by using a demand-
supply diagram; show this. Assume that the marginal private cost curve slopes upward.
Chapter 17 Externalities and the Environment 238
4. (Negative Externalities) Review the situation illustrated in the graph above [Exhibit 1]. If the
government sets the price of electricity at the socially optimal level, why is the net gain equal to
triangle abc, even though consumers now pay a higher price for electricity? What would the net
gain be if the government set the price above the optimal level?
A net gain occurs at the optimal price because the loss of benefits to consumers as a result of
Chapter 17 Externalities and the Environment 239
5. (External Costs) Use the data in the table below to answer the following questions:
a. What is the marginal external cost per unit of production?
b. What level is produced if there is no regulation of the externality?
c. What level should be produced to achieve economic efficiency?
d. Calculate the dollar value of the net gain to society from correcting the externality.
Marginal Private Marginal Private Marginal
Quantity Benefit (Demand) Cost (Supply) Social Cost
0 — $ 0 $ 0
1 $10 2 4
2 9 3 5
3 8 4 6
4 7 5 7
5 6 6 8
6 5 7 9
7 4 8 10
8 3 9 11
9 2 10 12
10 1 11 13
a. The per-unit external cost is $2, the difference between marginal private and social costs.
6. (External Costs with Variable Technology) Think of an industry that pollutes the water and has
access to variable technology for reducing that pollution. Graphically illustrate and explain the
impact of each of the following, other things constant, on the optimal level of water quality:
a. New evidence is discovered about a greater risk of cancer from water pollution.
Chapter 17 Externalities and the Environment 240
Chapter 17 Externalities and the Environment 241
7. (Market for Pollution Rights) The following graph shows the market for pollution rights.
a. If there are no restrictions on pollution, what amount is discharged?
b. What is the quantity supplied and the quantity demanded if the government restricts the
amount of discharge to Q* but gives the permits away?
c. Where is market equilibrium if the government sells the permits? Illustrate this on the graph.
d. What happens to market equilibrium if the government reduces the amount of discharge
permitted to Q**? Illustrate this on the graph.
a. Refer to the following graph. If there are no restrictions, the amount of discharge equals Q.
8. (Environmental Protection) Four federal laws and subsequent amendments underpin U.S. envi-
ronmental protection. Identify these laws.
Chapter 17 Externalities and the Environment 242
In 1970, the federal government passed the Clean Air Act, which set national standards for the
amount of pollution that could be released into the atmosphere. The Clean Water Act of 1972
9. (Positive Externalities) The value of a home depends in part on how attractive other homes and
yards in the neighborhood are. How do local zoning ordinances try to promote land uses that
generate external benefits for neighbors?
Local zoning ordinances try to promote residential land uses that create external benefits for the
neighborhood as a whole. Zoning an area as strictly residential protects homeowners. Placing
Experiential Assignments
1. Suggest the following scenario to your students: Suppose you are the mayor of Mexico City. How
can you use some of the techniques outlined in this chapter to control pollution there? (For back-
ground information, have students check http://www. ess.co.at/GAIA/CASES/MEX/index.html.)
2. Garrett Hardin’s 1968 article, “The Tragedy of the Commons,” is available online at
3. Students should search on “cap and trade” and read a selection of entries. Based on what they’ve
learned in this chapter, have them evaluate the case for pollution permits as a way of controlling
negative externalities.
4. The Marketplace section of the Wall Street Journal is a good place to look for information related