Econ: Chapter 5

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What is an externality?

a benefit or cost that affects someone not directly involved in the production or
consumption of a good or service

Describe negative externalities.

1. costs imposed on individuals not directly
involved in producing or consuming a good or service
2.causes the social cost of production
of a good or service to exceed the private cost borne by the producer
3. causes output to exceed the
economically efficient amount

Describe positive externalities.

1. benefits received by
individuals not directly involved in producing or consuming a good or service
2. causes the social benefit from consuming a
good or service to exceed the private benefit
3. causes output to be less than the
economically efficient amount

What is the result of negative and positive externalities?

market failure

What is the underlying cause of externalities and other forms of market failure?

The absence of private property rights or the
lack of sufficient enforcement of existing property rights

When are private solutions possible and efficient?

if there are low transactions costs

Describe the command and control approach.

the government sets specific quantitative limits

Describe rivalry.

occurs when consumption of one unit of a good precludes its consumption by someone else

Describe excludability.

means that anyone who does not pay for a good cannot consume it

Describe tragedy of the commons.

One
person's use of a common resource can impose costs on others

What is a private cost?

a cost borne by the producer of a good or service

What is a social cost?

the total cost of
production, including both the private cost and any external cost

What is a private benefit?

the benefit received
by the consumer of a good or service

What is a social benefit?

the total benefit from consuming a good,
including both the private benefit and any external benefit

What are property rights?

the rights individuals or businesses have to the exclusive use of their property,
including the right to buy or sell it.

What is market failure?

situations where the market fails to produce the efficient level of output

Describe the Coase Theorem.

1. if transactions costs are low, private bargaining will result in an efficient
solution to the problem of externalities
2. services. Successful
application of the Coase Theorem requires that the bargaining parties have full information regarding the
costs and benefits associated with the externalities and are willing to accept a reasonable agreement

What are transaction costs?

the costs in time and other resources that
parties incur in the process of agreeing to and carrying out an exchange of goods and services

Describe Pigovian tax and subsidy.

1. cause consumers and firms to internalize the externalities
associated with production and consumption
2. The tax or subsidy would be equal to the dollar amount of
the externality

What is a private good?

a good that is both rival and excludable

What is a common resource?

a good that is rival but not excludable

What is a public good?

a good that is both
nonrivalrous and nonexcludable

Describe free riding?

1. benefiting from a good without paying for it
2. Because of free riders, public goods are usually supplied by government rather than private firms.

1. What is the cost that affects someone who is not directly involved in the production or consumption
of a good called?
a. Private cost
b. Indirect cost
c. An externality
d. All of the above fit that definition

c. An externality

2. What is the term used to describe the total cost of producing a good?
a. Private cost
b. Social cost
c. Externality
d. All of the above fit that definition.

b. Social cost

3. What is the difference between private benefit and social benefit?
a. An external benefit
b. Private cost
c. Social cost
d. A negative externality

a. An external benefit

4. What is the benefit received by the consumer of a good or service called?
a. Private benefit
b. Social benefit
c. Private cost
d. A positive externality

a. Private benefit

10. Fill in the blanks. When a negative externality is present in producing a good or service,
___________ of the good or service will be produced at market equilibrium.
a. too much
b. too little
c. the optimal quantity
d. none

a. too much

11. What is the situation called in which the market fails to produce the efficient level of output?
a. An externality
b. Market failure
c. External disequilibrium
d. The Coase Theorem

b. Market failure

12. When we talk about property rights in the discussion of externalities, which rights do we refer to?
a. The rights of individuals to pollute
b. The rights of individuals to have exclusive use of their property
c. The rights of individuals to buy but not sell their property
d. All of the above

b. The rights of individuals to have exclusive use of their property

13. What are the sources of externalities and market failure?
a. Incomplete property rights
b. The difficulty of enforcing property rights in certain situations.
c. Both a. and b.
d. Lack of understanding of the market system

c. Both a. and b.

14. What type of solution to externalities is the Coase Theorem?
a. A private solution to externalities
b. A public solution to externalities
c. The only solution to externalities
d. The least preferred solution

a. A private solution to externalities

15. Which of the following statements is correct according to Ronald Coase's argument for dealing with
externalities and market failure?
a. In some situations, a private solution to the problem of externalities can be found.
b. Only public solutions exist for solving externalities.
c. Completely eliminating an externality is almost always the most efficient solution.
d. The only cure to externalities is taxation.

a. In some situations, a private solution to the problem of externalities can be found

16. Which of the following is correct?
a. Completely eliminating an externality is usually not economically efficient.
b. As reductions in pollution increase, the additional benefits will decline.
c. When levels of pollution are high, the marginal benefit of reducing pollution is also high.
d. All of the above

d. All of the above

17. The net benefit to society from reducing pollution is equal to
a. the sum of the benefits of reducing pollution and the costs.
b. the difference between the benefits and the costs.
c. the additional benefit plus the additional costs.
d. the quantity of pollution, such as the tons of reduction in sulfur dioxide.

b. the difference between the benefits and the costs.

1. An externality is
A) a cost paid for by the producer of a good or service.
B) a benefit realized by the purchaser of a good or service.
C) a benefit or cost experienced by someone who is not a producer or consumer of a good or service.
D) anything that is external or not relevant to the production of a good or service.

C) a benefit or cost experienced by someone who is not a producer or consumer of a good or service

2. Which of the following is a source of market failure?
A) a lack of government intervention in a market
B) unforeseen circumstances which leads to the bankruptcy of many firms
C) an inequitable income distribution
D) incomplete property rights or inability to enforce property rights

D) incomplete property rights or inability to enforce property rights

3. What is a market failure?
A) It refers to a breakdown in a market economy because of widespread corruption in government.
B) It refers to a situation where an entire sector of the economy (for example, the airline industry) collapses
because of some unforeseen event.
C) It refers the inability of the market to allocate resources efficiently up to the point where marginal social
benefit equals marginal social cost.
D) It refers to the inability of the market to allocate resources efficiently up to the point where marginal social
benefit equals marginal private cost

C) It refers the inability of the market to allocate resources efficiently up to the point where marginal social
benefit equals marginal social cost.

4. Which of the following activities create a negative externality?
A) graduating from college
B) keeping a junked car parked on your front lawn
C) cleaning up the sidewalk on your block
D) repainting the house you live in to improve its appearance

B) keeping a junked car parked on your front lawn

5. A negative externality exists if
A) there are price controls in a market.
B) the marginal social cost of producing a good or service exceeds the private cost.
C) there are quantity controls in a market.
D) the marginal private cost of producing a good or service exceeds the social cost

B) the marginal social cost of producing a good or service exceeds the private cost.

6. Private costs
A) are borne by producers of a good while social costs are borne by those who cannot afford to purchase the
good.
B) are borne by consumers of a good while social costs are borne by government.
C) are borne by producers of a good while social costs are borne by government.
D) are borne by producers of a good while social costs are borne by society at large.

D) are borne by producers of a good while social costs are borne by society at large.

. An external cost can be calculated as the difference between
A) the social cost of production and the social benefit of production.
B) the private cost of production and the social benefit of production.
C) the social cost of production and the private cost of production.
D) a producer's cost of production and the price at which the good is sold.

C) the social cost of production and the private cost of production

8. The social cost of cutting trees for firewood in a government forest is
A) the increased likelihood of flooding as more trees are cut.
B) the marginal costs of cutting the last tree.
C) opportunity cost to the individual of cutting the wood.
D) the increased likelihood of flooding as more trees are cut plus the private cost of cutting the trees.

D) the increased likelihood of flooding as more trees are cut plus the private cost of cutting the trees

9. Which of the following represents the economic benefit of production when firms produce goods that create
positive externalities?
A) the difference between social benefits and private benefits created by the goods.
B) the sum of private benefits from consumption.
C) the external benefits created by the goods.
D) the sum of private benefits and external benefits created by the goods.

D) the sum of private benefits and external benefits created by the goods.

10. A positive externality causes
A) the marginal social benefit to be equal to the marginal private cost of the last unit produced.
B) the marginal private benefit to exceed the marginal social cost of the last unit produced.
C) the marginal social benefit to be less than the marginal private cost of the last unit produced.
D) the marginal social benefit to exceed the marginal private cost of the last unit produced.

D) the marginal social benefit to exceed the marginal private cost of the last unit produce

14. When there is a negative externality in a free market,
A) too little of the good is produced and consumed.
B) an economically efficient level of the good is produced and consumed.
C) a productively efficient level of the good is produced and consumed.
D) too much of the good is produced and consumed.

D) too much of the good is produced and consumed

20. Which of the following conditions holds in an economically efficient competitive market equilibrium?
A) There are no positive and no negative external effects from consumption and production.
B) The marginal benefit of the last unit produced and consumed is maximized.
C) Producer and consumer surplus are exactly equal in size.
D) The deadweight loss is positive but at a minimum.

A) There are no positive and no negative external effects from consumption and production.

21. A market demand curve reflects the
A) social benefits of consuming a product.
B) the sum of private and social benefits of consuming a product.
C) private benefits of consuming a product.
D) external benefits of consuming a product

C) private benefits of consuming a product.

22. Which of the following statements is false?
A) Social benefits are external benefits minus private benefits.
B) Social costs are private costs and any external costs.
C) Private benefits are received by the consumer of the good or service.
D) Private costs are borne by the producer of the good or service.

A) Social benefits are external benefits minus private benefits.

27. In which of these situations is there no deadweight loss?
A) free market production of a private good with a negative externality
B) free market consumption of a private good with a positive externality
C) consumption of a common resource without government restrictions
D) free market production and consumption of a private good without any externalities

D) free market production and consumption of a private good without any externalities

28. Economists argue that the level of pollution should be
A) ignored because it has always been present since the beginning of history.
B) best determined by elected officials who can speak on behalf of the public.
C) reduced completely to zero because by definition, it is a negative external effect.
D) reduced to the point where the marginal benefit of pollution reduction is equal to the marginal cost of
pollution reduction to society.

D) reduced to the point where the marginal benefit of pollution reduction is equal to the marginal cost of
pollution reduction to society

29. The Coase theorem states that
A) government intervention is always needed if externalities are present.
B) a free market equilibrium is the best solution to address externalities.
C) if transactions costs are low, private bargaining will result in an efficient solution to the problem of
externalities.
D) assigning property rights is the only thing the government should do in a market economy

C) if transactions costs are low, private bargaining will result in an efficient solution to the problem of
externalities.

30. If the paint on your house was eaten away by the fumes from a factory nearby and you hired a lawyer to sue the
polluting firm, your legal fees would be considered
A) external costs.
B) social costs of the pollution.
C) marginal benefits.
D) transaction costs

D) transaction costs.

31. Consider the following characteristics:
a. low transaction costs
b. small levels of pollution
c. high levels of pollution
d. clear assignment of property rights.
Which of the above are assumptions behind the Coase Theorem?
A) a and d
B) a, b, and d
C) a, c, and d
D) a only

A) a and d

32. In the city of Alvarez, with the exception of guide dogs for blind people, all dogs are banned from its three
public parks, regardless of whether the animals are leashed. Many residents are pushing for a change in policy.
Canine lover Sara Northridge observed, "There are 800 or more homes here. There are three parks within 10
minutes, and almost everyone has a dog, but we can't take our dogs there." Others fear that allowing dogs
would detract from their enjoyment of the parks. Tim Cortis retorted, "We're not preventing dog lovers from
enjoying the park, just come without your dog." Which of the following is a way of dealing with the problem by
assigning property rights to a particular group?
A) impose a fee only for dog-owners to use the public parks; non dog owners do not pay a fee
B) impose a two-tier entry fee system - a lower fee for non dog owners and a higher fee for dog owners
C) dedicate some parks, or at least one park, exclusively for the use of visitors bringing dogs to the park.
D) allow dog owners to bring their dogs to the park but insist that they keep watch over their dogs

C) dedicate some parks, or at least one park, exclusively for the use of visitors bringing dogs to the park

33. In the United States, many beekeepers travel from state to state, renting out their bee colonies to farmers for
pollination services. This is an example of
A) a tradable exchange contract.
B) a Pigouvian solution to a positive externality problem.
C) command and control policy.
D) a Coasian solution to a positive externality problem.

D) a Coasian solution to a positive externality problem

34. What does the phrase "internalizing an external cost" mean?
A) forcing producers to factor into their production costs, the cost of the externalities created in the
production of their output
B) prohibiting economic activities that create externalities
C) limiting the extent to which domestic firms can outsource production
D) finding a way to address cross-border pollution

A) forcing producers to factor into their production costs, the cost of the externalities created in the
production of their output

35. An advantage of imposing a tax on the producer that generates pollution is that
A) it will eliminate pollution.
B) the government can keep tabs on exactly what is produced in an industry.
C) a producer can pass the cost of the pollution to consumers.
D) it forces the polluting producer to internalize the external cost of the pollution.

D) it forces the polluting producer to internalize the external cost of the pollution

36. Suppose a tax equal to the value of the marginal external cost at the optimal output is imposed on a pollution
generating good. All of the following will result from the tax except
A) a decrease in market supply of the good.
B) an increase in the equilibrium market price.
C) a decrease in the equilibrium quantity produced and consumed.
D) an increase in the demand for the good

D) an increase in the demand for the good.

37. Governments can increase the consumption of a product that creates positive externalities by
A) assigning property rights to the producers of the product.
B) taxing the production and consumption of the product.
C) convincing everyone to consume the good.
D) subsidizing the production of the product so that the supply is increased and market price is reduced

D) subsidizing the production of the product so that the supply is increased and market price is reduced.

39. Government imposed quantitative limits on the amount of pollution firms are allowed is an example of
A) a tradable emission allowance system of pollution control.
B) the Pigovian method of pollution control.
C) Coasian solution to pollution reduction.
D) command and control approach to pollution reduction

D) command and control approach to pollution reduction

Issuing marketable emission allowance permits to polluting firms
A) gives the industry the right to a specific level of pollution.
B) generates income for the government.
C) has the same impact as a subsidy on production.
D) encourages more pollution.

A) gives the industry the right to a specific level of pollution

41. Compared to the command and control approach to pollution control, the tradable emissions allowance system
is
A) less efficient, because the tradable emissions allowance system gives firms the right to pollute a certain
amount.
B) less efficient, because it does not raise funds for the government whereas under the command and control
approach, firms are penalized for non-compliance.
C) more efficient, because firms with low costs of pollution control would pollute the least and sell their extra
permits to other firms with higher costs of pollution control.
D) more efficient, because there are implementation and monitoring costs with the tradable emissions
allowance system.

C) more efficient, because firms with low costs of pollution control would pollute the least and sell their extra
permits to other firms with higher costs of pollution control.

Anyone can purchase sulfur dioxide emissions allowances on the Chicago Mercantile Exchange. Several
environmental groups have raised money to buy allowances (which it subsequently destroys). As part of their
fund-raising, these groups have urged contributors to buy the allowances as gifts. As one newspaper story put
it, "For the environmentalist in your life, here's a gift that is sold by the ton, fits in an envelope and will last
forever."
Source for quote: Randall Edwards, "Dear Santa: Please Bring Me Sulfur Dioxide for Christmas," Columbus Dispatch, December
19, 1999.
What would be the impact on the price of the emission allowances in the market?
A) The price rises.
B) The price falls but not to zero.
C) The price remains unchanged because the allowances purchased by the environmental groups are
destroyed.
D) The price falls to zero.

A) The price rises.

43. Under the European Union's tradable carbon emissions rights scheme, utilities are given a set level of permits to
emit carbon dioxide. If a utility wants to pollute more than its allowance it could buy more permits in the
market. Under what situation will a utility that wants to pollute more than its allowance not purchase
additional permits?
A) if there is an excess demand for permits in the market
B) if it is cheaper to switch from heavy polluting energies to cleaner fuels than to purchase pollution permits
C) if it is cheaper to burn heavy polluting energies than to switch to cleaner fuels
D) if the market price of a permit is so low that it has virtually no resale value

B) if it is cheaper to switch from heavy polluting energies to cleaner fuels than to purchase pollution permits

A product is considered to be nonexcludable if
A) you cannot keep those who did not pay for the item from enjoying its benefits.
B) your consumption of the product reduces the quantity available for others to consume.
C) you can keep those who did not pay for the item from enjoying its benefits.
D) it is jointly owned by all members of a community

A) you cannot keep those who did not pay for the item from enjoying its benefits.

5. Which of the following displays these two characteristics: rivalry and nonexcludability?
A) a private good.
B) a common resource.
C) a quasi-public good.
D) a public good.

B) a common resource

. Which of the following displays nonrivalry and nonexcludability in consumption?
A) quasi-public goods
B) public goods
C) common resources
D) private goods

B) public goods

7. Which of the following is an example of a product that is nonexcludable and rivalrous?
A) free concert (with limited seating) in a park
B) flu vaccinations
C) automobiles
D) national defense

A) free concert (with limited seating) in a park

8. Common resources differ from public goods in that
A) common resources are collectively owned by a group of people while public goods are government
owned.
B) unlike public goods, common resources are rivalrous in consumption.
C) common resources are resources that cannot be renewed but the production of public goods can be
increased any time.
D) common resources are non-excludable while public goods are excludable to those who do not pay for the
good.

B) unlike public goods, common resources are rivalrous in consumption

49. In economics, the term "free-rider" refers to
A) one who waits for other s to produce a good and then enjoys its benefits without paying for it.
B) a supervisor who delegates menial time-consuming activities to others
C) a person who evades taxes.
D) one who volunteers her services.

A) one who waits for other s to produce a good and then enjoys its benefits without paying for it

50. How does the construction of a market demand curve for a private good differ from that for a public good?
A) The market demand curve for a private good is determined by adding up the quantities demanded by
each consumer at each price but the market demand curve for a public good is determined by adding up
the price each consumer is willing to pay for each quantity of the good.
B) There is no difference; in both cases the demand curve is determined by adding up the quantities
demanded by each consumer at each price
C) There is no difference; in both cases the demand curve is determined by adding up the price each
consumer is willing to pay for each quantity of the good.
D) The market demand curve for a private good is determined by adding up the price each consumer is
willing to pay for each quantity of the good but the market demand curve for a public good is determined
by adding up but the quantities demanded by each consumer at each price.

A) The market demand curve for a private good is determined by adding up the quantities demanded by
each consumer at each price but the market demand curve for a public good is determined by adding up
the price each consumer is willing to pay for each quantity of the good.

51. The efficient output level of a public good occurs where the
A) greatest number of free riders occurs.
B) marginal cost of producing the last unit is equal to the marginal benefit realized by consumers.
C) marginal cost of production is at its lowest.
D) total cost of production is affordable.

B) marginal cost of producing the last unit is equal to the marginal benefit realized by consumers.

52. For-profit producers will produce only private goods because
A) buyers will be willing to pay for the goods since the benefits are excludable.
B) the cost of production can be easily determined easily found.
C) markets exist for private goods but not for public goods.
D) all external benefits can be internalized using market prices.

A) buyers will be willing to pay for the goods since the benefits are excludable.

53. According to an article in the Wall Street Journal, economist Paul Romer of Stanford University has argued:
"The market mechanism and property rights are excellent at conserving scarce resources and putting them to
the most profitable use. They aren't so good at encouraging the production and distribution of new ideas,
which are critical to progress."
Source: David Wessel, "Precepts from Professor Summers," Wall Street Journal, October 17, 2002.
What characteristics of the production and distribution of new ideas might make it difficult for the market to
produce the optimal amount?
A) rivalry and non-excludability
B) rivalry and excludability
C) rivalry and excludability
D) non-rivalry and non-excludability

D) non-rivalry and non-excludability

54. The "tragedy of the commons" refers to the phenomenon where
A) individuals are free riders.
B) there is rivalry in consumption.
C) people do not internalize an externality.
D) people overuse a common resource

D) people overuse a common resource.

55. Which of the following exemplifies the tragedy of the commons?
A) The Pleasant Hill community is growing so fast that the city's only post office is not able to keep pace with
the population growth in the community.
B) Residents in the northern coast of California receive only one public broadcasting signal which may be
eliminated altogether if government funding is cut.
C) Canadian citizens receive free universal health care administered by provincial governments.
D) The Malaysian tapir, distinguished for its unusual coloration, is a target for poachers who hunt it for its
tough and leathery hide.

D) The Malaysian tapir, distinguished for its unusual coloration, is a target for poachers who hunt it for its
tough and leathery hide.

56. Consider the stock of ocean tuna which is massively overfished. It is rational for an individual to exploit the
resource rather than to conserve the stock because
A) the social cost of harvesting the fish is lower than the private cost.
B) the private cost of harvesting the fish is lower than the social cost.
C) the private benefit of harvesting tuna is lower than the social benefit of harvesting it.
D) the private benefit of harvesting tuna is higher than the social benefit of harvesting it.

B) the private cost of harvesting the fish is lower than the social cost

60. The basic cause of deadweight losses from the existence of common resources and externalities is
A) a lack of clearly defined and enforceable property rights.
B) the absence of government intervention.
C) the use of a market system to deal with scarcity.
D) the self interested rationality of human beings.

A) a lack of clearly defined and enforceable property rights.

61. Global warming refers to the effect of global pollutants such as carbon dioxide on climates on the earth.
Climate-induced changes in temperatures affect, among other things, agriculture. Which of the following is a
reason why policymakers are still debating if this problem should be addressed and how it should be
addressed?
A) Scientists agree about the damage caused by carbon emissions but disagree about the methods of reducing
emissions.
B) The marginal cost of reducing carbon emissions is known with certainly but the marginal benefit from
reduction is not known with certainty.
C) There is much disagreement about all aspects of the problem: how much carbon emissions contribute to
damage from climate change which in turn informs the benefits from reduction, and what methods to use
which in turn determines the cost of reduction
D) The marginal cost of reducing carbon emissions is not known with certainly but the marginal benefit from
reduction is known with certainty

C) There is much disagreement about all aspects of the problem: how much carbon emissions contribute to
damage from climate change which in turn informs the benefits from reduction, and what methods to use
which in turn determines the cost of reduction

62. Private producers have no incentive to provide public goods because
A) once produced, it will not be possible to exclude to those who do not pay for the good
B) they cannot avoid the tragedy of the commons.
C) the government subsidy granted is usually insufficient to enable private producer to make a profit.
D) production of huge quantities of public goods entails huge fixed costs.

A) once produced, it will not be possible to exclude to those who do not pay for the good

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