CHAPTER 5 | Externalities, Environmental Policy, and Public Goods

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is a benefit or cost to parties who are not involved in a transaction, can be positive or negative, arises when property rights don’t exist or can’t be enforced.
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An externality
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greater than the private cost
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A negative externality causes the social cost of production to be
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the benefit received by the consumer of a good or service; the total benefits from consuming the good
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Fill in the blanks. The private benefit is ________, while the social benefit is ________.
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a situation where the market doesn’t produce the optimal level of a good or service because of externality, can be a consequence of externalities.
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Market failure is
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can; can
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Fill in the blanks. Positive externality_________ cause a market failure and negative externality_________ cause a market failure.
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if transaction costs are low, private bargaining will lead to an efficient solution to externalities
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The Coase theorem states that
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the rights of individuals to have exclusive use of their property
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When we talk about property rights in the discussion of externalities, which rights do we refer to?
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market failure, deadweight loss.
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Externalities result in
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the bargaining parties have full information regarding the costs and benefits associated with the externalities, the bargaining parties are willing to accept a reasonable agreement, transaction costs are low.
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Successful application of Coase theorem requires that
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less; more
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Fill in the blanks. Positive externality results in producing _________ than the economically efficient level of output, whereas negative externality results in producing _________ than the economically efficient level of output.
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the quantity of the good demanded by each consumer at each price; the price each consumer is willing to pay for each quantity of the good
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Fill in the blanks. To get the market demand curve for a private good, you add _________. To get the market demand curve for a public good, you add_________.
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Higher education; neighbor’s dog barking all night
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Fill in the blanks. _________ causes a positive externality, while a _________ causes a negative externality.
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The marginal benefit from another ton of reduction should be equal to the marginal cost
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If we are considering further reductions in pollution, what rule should we follow to maximize the net benefit to society?
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internalize the externality associated with production or consumption, bring about the efficient level of output in the presence of externality.
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Pigovian taxes and subsidies are intended to
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private bargaining between the parties
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Fill in the blank. According to the Coase theorem, if transaction costs are low ________ will result in an efficient solution to the externality problem
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is used to reduce pollution, involves the government imposing quantitative limits on the amount of pollution firms are allowed to generate.
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The command-and-control approach
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Pigovian tax and subsidy, command-and-control approach.
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To deal with externalities, the government uses
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nonrival and nonexcludable; rival and excludable
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Fill in the blanks. A public good is ________, while a private good is _________.
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rival but not excludable
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A common resource is
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excludable but not rival
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A quasi-public good is
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The tragedy of the commons refers to the tendency for a common resource to be overused
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What is the tragedy of the commons?
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Since the passage of the Clean Air Act in 1970, emissions of the six main forms of air pollution have fallen by almost half. With the lower level of air pollution, the marginal benefit (due to the reduction in illness, etc.) of reducing air pollution by an equivalent amount today would be much less.
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1. Explain why the marginal benefit from reducing air pollution in the United States in 1970 was greater than the marginal benefit of reducing air pollution by an equivalent amount would be today.
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Cheung noted that intervention by government was not necessary to address the problem because beekeepers and apple growers came to their own solution. Contracts are written between these two groups that specify payments between the parties. This is what the Coase theorem is about: Private negotiation between parties involved to reach an efficient outcome to externalities as long as transaction costs are low.
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2. Steven Cheung of the University of Washington has written about the positive externalities associated with beekeeping and apple growing. Explain why the solution to this externalities problem is an application of the Coase theorem.
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The marginal cost of reducing the last amounts of air and water pollution—the amounts that would remain when nearly all forms of pollution were eliminated—would be very high. It might be necessary, for example, to ban all automobiles. The marginal benefit from reducing the last amounts of pollution would be low.
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3. Air and water pollution impose external costs on people without their consent. Why isn’t it economically efficient to completely eliminate these external costs by reducing the amounts of air and water pollution to zero?
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Yes, you should agree with the statement. To get the market demand curve for a private good, we add the quantity of the good demanded by each consumer at each price. Because the quantity is measured on the horizontal axis, we add horizontally. To get the market demand curve for a public good, we add the price each consumer would be willing to pay for each quantity. Because the price is measured on the vertical axis, we add vertically
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4. In order to get the market demand curve for a private good, we add horizontally, while for the market demand curve for the public good, we add vertically. Do you agree with this statement? Explain your answer.
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The student is wrong: Both positive and negative externalities interfere with economic efficiency. Positive externality causes the social benefit from consuming the good to exceed the private benefits. Negative externality, on the other hand, causes the social cost of production to exceed the private cost.
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5. A student argues that \”Negative externality interferes with economic efficiency because it is negative, whereas positive externality does not.\” Comment on this argument.
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F
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TF: Positive externality causes the level of output produced to be more than the efficient level of output
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T
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TF: Externality can cause a deadweight loss.
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T
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TF: Higher education causes positive externalities.
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T
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TF: Negative externality causes the social cost of producing a good to exceed its private cost
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T
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TF: The federal government rather than private firms provides national defense because consumers of national defense have an incentive to be free riders.
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F
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TF: Congress authorized a command-and-control approach to reducing sulfur dioxide emissions by electric utilities in 1990.
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F
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TF: The Coase theorem states that if transaction costs are high, private bargaining between the parties involved can lead to an efficient level of output produced.
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T
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TF: Pigovian tax or subsidy cause consumers and firms to internalize the externalities associated with consumption and production of the good
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T
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TF: If the marginal cost of reducing emissions of some pollutant is greater than the marginal benefit, society will be better off if these emissions are increased.
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T
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TF: Free riding means that you benefit from the good without paying for it.
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F
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TF: The tragedy of the commons refers to the tendency for a common resource to be underused.
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T
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TF: The 1983 requirement by the federal government to install catalytic converters on all new automobiles is an example of a command-and-control approach to reducing pollution.
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F
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TF: The actual cost to electric utilities of complying with Congress’ program to reduce sulfur dioxide emissions in 2010 is greater than was originally estimated by the General Accounting Office in 1994.
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F
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TF: Most European governments favor an international system of tradable emissions permits to reduce carbon dioxide emissions. The U.S. government favors a program that would require individual countries to reduce emissions by a specified amount.
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T
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TF: The demand for a public good is determined by adding the price each consumer is willing to pay for each quantity of the public good

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