8.

Chapter 10 Externalities

Figure 10-1

1. Refer to Figure 10-1. This graph represents the tobacco industry. The industry creates
  a. positive externalities.
  b. negative externalities.
  c. no externalities.
  d. no equilibrium in the market.
ANSWER:  b

2. A negative externality arises when a person engages in an activity that has
  a. an adverse effect on a bystander who is not compensated by the person who causes the
effect.
  b. an adverse effect on a bystander who is compensated by the person who causes the effect.
  c. a beneficial effect on a bystander who pays the person who causes the effect.
  d. a beneficial effect on a bystander who does not pay the person who causes the effect.
ANSWER:  a

3. Which of the following is an example of an externality?

  a. cigarette smoke that permeates an entire restaurant
  b. a flu shot that prevents a student from transmitting the virus to her
roommate
  c. a beautiful flower garden outside of the local post office
  d. All of the above are correct.
ANSWER:  d
4. Josiah installed a metal sculpture in his front yard. A negative externality arises if the sculpture
  a. increases the value of other properties in the
neighborhood.
  b. decreases the value of Josiah’s home.
  c. is visually appealing to Josiah’s neighbors.
  d. creates a safety hazard for neighborhood children.
ANSWER:   d

This figure reflects the market for outdoor concerts in a public park surrounded by residential
neighborhoods.

Figure 10-3

5. Refer to Figure 10-3. The social cost curve is above the supply curve because
  a. it takes into account the external costs imposed on society by the concert.
  b. it takes into account the effect of local noise restrictions on concerts in parks surrounded by
residential neighborhoods.
  c. concert tickets are likely to cost more than the concert actually costs the organizers.
  d. residents in the surrounding neighborhoods get to listen to the concert for free.
ANSWER:  a

6. Refer to Figure 10-3. The difference between the social cost curve and the supply curve reflects the
  a. profit margin of each concert.
  b. cost of spillover effects from the concert (e.g., noise and traffic).
  c. value of concerts to society as a whole.
  d. amount by which the city should subsidize the concert organizers.
ANSWER:  b

7. Refer to Figure 10-3. At the private market outcome, the equilibrium price will be
   a.  P0.
  b. P1.
  c.  P2.
  d. None of the above is correct.
ANSWER:  b

8. Refer to Figure 10-3. What price and quantity combination best represents the optimum price and
number of concerts that should be organized?
  a.  P1, Q1
  b. P2, Q0
  c.  P2, Q1
  d. The optimum quantity is zero concerts as long as residents in surrounding neighborhoods are
adversely affected by noise and congestion.
ANSWER:  b

Figure 10-4

9. Refer to Figure 10-4. If this market is currently producing at Q4, then total economic well-being
would be maximized if output
  a.  decreased to Q1.
  b. decreased to Q2.
  c.  decreased to Q3.
  d. stayed at Q4.
ANSWER:  b

10. Refer to Figure 10-4. This market is characterized by

  a. government intervention.
   b. a positive externality.
  c. a negative externality.
  d. None of the above is correct.
ANSWER:  c

11. Refer to Figure 10-4. Without government intervention, the equilibrium quantity would be
  a.  Q1.
  b. Q2.
  c.  Q3.
  d. Q4.
ANSWER:  c

12. Refer to Figure 10-4. The socially optimal quantity would be

  a.  Q1.
  b. Q2.
  c.  Q3.
  d. Q4.
ANSWER:  b

13. Refer to Figure 10-4. This market

  a. has no need for government intervention.
  b. would benefit from a tax on the product.
  c. would benefit from a subsidy for the product.
  d. would maximize total well-being at Q3.

ANSWER:  b

14. Refer to Figure 10-4. If all external costs were internalized, then the market’s equilibrium output
would be
  a.  Q1.
  b. Q2.
  c.  Q3.
  d. Q4.
ANSWER:  b

15. Refer to Figure 10-4. At Q3

  a. the marginal consumer values this product less than the social cost of producing
it.
  b. every consumer values this product less than the social cost of producing it.
  c. the cost to society is equal to the value to society.
   d. the marginal consumer values this product more than the private cost.
ANSWER:  a
Table 10-4

Quantity Private Value Private Cost External Cost

1 $46 $21 $6
2 $44 $24 $6
3 $42 $27 $6
4 $40 $30 $6
5 $38 $33 $6
6 $36 $36 $6
7 $34 $39 $6

16. Refer to Table 10-4. The table represents a market in which

  a. there is no externality.
  b. there is a positive externality.
  c. there is a negative externality.
  d. The answer cannot be determined from inspection of the table.
ANSWER:  c

17. Refer to Table 10-4. The social cost of the 2nd unit of output that is produced is
  a. $7.
  b. $23.
  c. $30.
  d. $38.
ANSWER:  c

18. Refer to Table 10-4. The last unit of output for which private value exceeds social cost is the
  a.  2nd unit.
  b. 3rd unit.
  c.  4th unit.
  d. 5th unit.
ANSWER:  c

19. Refer to Table 10-4. The market equilibrium quantity of output is

  a. 3 units.
  b. 4 units.
  c. 5 units.
  d. 6 units.
ANSWER:  d

20. Refer to Table 10-4. Take into account private and external costs and assume the quantity of output
is always a whole number (that is, fractional units of output are not possible). The maximum total surplus
 that can be achieved in this market is
  a. $29.
  b. $35.
  c. $40.
  d. $46.
ANSWER:  d

21. Refer to Table 10-4. Taking into account private and external costs, total surplus in the market
equilibrium amounts to
  a. $28.
  b. $39.
  c. $45.
  d. $51.
ANSWER:  b

22. Refer to Table 10-4. Which of the following policies would move the market from the market
equilibrium to the socially optimal equilibrium?
  a. a tax of $4 per unit of output
  b. a subsidy of $4 per unit of
output
  c. a tax of $6 per unit of output
  d. a subsidy of $6 per unit of
output
ANSWER:  c

Essay Questions

1. Using a supply and demand diagram, demonstrate how a negative externality leads to market
inefficiency. How might the government help to eliminate this inefficiency?
ANSWER:  
 When a negative externality exists, the private cost (or supply curve) is less than the social
cost. The market equilibrium quantity of Q0 will be greater than the socially optimal quantity
of Q1. The government could help eliminate this inefficiency by taxing the product. In this
example, the size of the per-unit tax would be P3 - P1 (or P2 - P0).
2. Using a supply and demand diagram, demonstrate how a positive externality leads to market
inefficiency. How might the government help to eliminate this inefficiency?
ANSWER:  

When a positive externality exists, the private value (or demand curve) is less than the social
value. The market equilibrium quantity will be less than the socially optimal quantity. The
government could help eliminate this inefficiency by subsidizing the product. In this example,
the size of the per-unit subsidy would be P3 - P1.