Test Bank for Principles of Economics 8th Edition N.

Gregory Mankiw

Test Bank for Principles of Economics 8th Edition N.

Gregory Mankiw

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-gregory-mankiw/

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Name: Class: Date:

Sec All: Short Answer and Essay (Ch 10)

Subjective Short Answer

1. Does research into new technologies create a positive externality or does it create a negative externality?
ANSWER: Research into new technologies creates a positive externality.

2. Does the phenomenon of externalities strengthen the argument that we should rely upon the “invisible hand” of the
marketplace, or does it weaken that argument?
ANSWER: The phenomenon of externalities weakens the argument for the “invisible hand.”

3. Bruce engages in an activity that diminishes the well-being of Shawna. Bruce pays no compensation to Shawna for her
loss in well-being. What specific term do economists use to describe this situation?
ANSWER: The term is negative externality.

4. Sheryl sits on her patio and plays her guitar while her neighbors are outside. Sheryl neither pays nor receives any
compensation for playing her guitar. Under what condition does her guitar-playing give rise to a positive externality?
ANSWER: Sheryl’s guitar-playing gives rise to a positive externality if it enhances the well-being of her neighbors.

5. Does the restoration of historic buildings create a positive externality or does it create a negative externality?
ANSWER: The restoration of historic buildings creates a positive externality.

6. Briefly explain how research into new technologies gives rise to a positive externality.
ANSWER: Research into new technologies gives rise to a positive externality in that it creates knowledge that other
people can use, thereby improving their well-being.

7. At any given quantity, the willingness to pay of the marginal buyer is the height of the __________.
ANSWER: demand curve

8. At any given quantity, the cost of the marginal seller is the height of the __________.
ANSWER: supply curve

Scenario 10-2
The demand curve for restored historic buildings slopes downward and the supply curve for restored historic buildings
slopes upward. The production of the 50th restored historic building entails the following:

• a private cost of $800,000;

• a private value of $650,000;
• a social value of $800,000.
9. Refer to Scenario 10-2. Is there an externality associated with this market? If your answer is “Yes,” is the externality
positive or negative?
ANSWER: There is a positive externality associated with this market.

10. Refer to Scenario 10-2. Is there an external cost associated with the restoration of the 50th historic building, or is
there an external benefit? What is the amount of that external cost or external benefit?
ANSWER: There is an external benefit of $150,000 associated with the restoration of the 50th historic building.

11. Refer to Scenario 10-2. Is the market equilibrium quantity of restored historic buildings less than, equal to, or greater
than 50?

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ANSWER: The market equilibrium quantity of restored historic buildings is less than 50.

12. Refer to Scenario 10-2. Is the socially optimal quantity of restored historic buildings less than, equal to, or greater
than 50?
ANSWER: The socially optimal quantity of restored historic buildings is equal to 50.

13. Refer to Scenario 10-2. Could the government impose a tax or provide a subsidy to move the market to the social
optimum? If your answer is “Yes,” should it be a tax or should it be a subsidy?
ANSWER: The government could move the market to the social optimum by providing a subsidy.

Scenario 10-3

Suppose the equation for the demand curve in a market is P = 120 - (1/5) QD , where QD is the quantity demanded and
is the price. Also, suppose the equation for the supply curve in the same market is P = (1/10) QS , where QS is the
quantity supplied.
14. Refer to Scenario 10-3. What are the market equilibrium quantity and price?
ANSWER: The market equilibrium quantity is 400 and the market equilibrium price is 40.

15. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What particular tax or subsidy would move the market to the social optimum?
ANSWER: A tax of $12 per unit would move the market to the social optimum.

16. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What is the equation of the social-cost curve?
ANSWER: The equation of the social-cost curve is P' = 12 + (1/10)QS .

17. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What is the social cost of producing 30 units of the good?
ANSWER: The social cost of producing 30 units of the good is $15.

18. Refer to Scenario 10-3. Suppose there is an external cost of $12 associated with the production of each unit of the
good. What are the socially optimal quantity and price?
ANSWER: The socially optimal quantity is 360 and the socially optimal price is 48.

19. Suppose the market-equilibrium quantity of good x is larger than the socially-optimal quantity of good x. Does the
production of good x convey a positive externality or does it convey a negative externality?
ANSWER: The production of good x conveys a negative externality.

20. Suppose the socially-optimal quantity of good x is larger than the market-equilibrium quantity of good x. Does the
production of good x convey a positive externality or does it convey a negative externality?
ANSWER: The production of good x conveys a positive externality.

21. Suppose a tax is imposed on producers of aluminum as a means of internalizing the externality associated with
aluminum production. If the tax accurately reflects the external costs of pollutants released into the atmosphere, then the
new supply curve for aluminum coincides with which other curve?
ANSWER: The new supply curve coincides with the social-cost curve.

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Sec All: Short Answer and Essay (Ch 10)

22. Suppose a subsidy is offered to consumers of education as a means of internalizing the externalities associated with
education. If the subsidy accurately reflects the external benefits of education, then the new demand curve for education
coincides with which other curve?
ANSWER: The new demand curve coincides with the social-value curve.

23. Assume each gallon of gasoline that is produced gives rise to an external cost of $1.25. On any given day, the
production of the 10,000th gallon of gasoline entails a private value of $4.00 and a social cost of $3.50. What is the private
cost of the 10,000th gallon?
ANSWER: For each gallon, the social cost is equal to the sum of the private and external costs. Thus, the private cost of
the 10,000th gallon is $3.50 - $1.25 = $2.25.

24. Assume each college degree that is granted conveys an external benefit of $3,500. The granting of the 500th college
degree entails a private cost of $15,000 and a private value of $25,000. What is the social value of the 500th college
degree?
ANSWER: For each college degree, the social value is equal to the sum of the private value and external benefit. Thus,
the social value of the 500th college degree is $25,000 + $3,500 = $28,500.

Scenario 10-4
The demand curve for fire extinguishers slopes downward and the supply curve for fire extinguishers slopes upward. The
production of the 500th fire extinguisher entails the following:

• a private cost of $10;

• an external cost of $0;
• a private value of $9;
• an external benefit of $3.
25. Refer to Scenario 10-4. Does the production of fire extinguishers convey a positive externality, a negative externality,
or neither?
ANSWER: The social value exceeds the private value, so the production of fire extinguishers conveys a positive
externality. The social cost is equal to the private cost, so there is no negative externality.

26. Refer to Scenario 10-4. What is the social value of the 500th fire extinguisher?
ANSWER: The social value is equal to the private value plus the external benefit, so the social value of the 500th fire
extinguisher is $12.

27. Refer to Scenario 10-4. In order to reach the social optimum, should fire extinguishers be taxed or subsidized? What
is the appropriate amount of the tax or subsidy on each fire extinguisher?
ANSWER: Each fire extinguisher should be subsidized by $3, which is the amount of the external benefit.

28. Refer to Scenario 10-4. Is the market-equilibrium quantity of fire extinguishers less than, equal to, or greater than
500? Explain.
ANSWER: For the 500th fire extinguisher, the private cost ($10) exceeds the private value ($9), so the market-
equilibrium quantity is less than 500.

29. Refer to Scenario 10-4. Is the socially-optimal quantity of fire extinguishers less than, equal to, or greater than 500?
Explain.
ANSWER: For the 500th fire extinguisher, the social value ($12) exceeds the social cost ($9), so the socially-optimal
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Sec All: Short Answer and Essay (Ch 10)

quantity is greater than 500.

30. Refer to Scenario 10-4. In order to maximize the total benefit of fire extinguishers to society as a whole, should the
number of fire extinguishers produced be less than, equal to, or greater than 500? Explain.
ANSWER: For the 500th fire extinguisher, the social value ($12) exceeds the social cost ($9), so the socially-optimal
quantity is greater than 500. The total benefit to society as a whole is maximized at the social optimum, so
more than 500 fire extinguishers should be produced.

31. When we identify public policies toward externalities, we contrast command-and-control policies with what other type
of policies?
ANSWER: The other type of policies is market-based policies.

32. Some policies toward externalities provide incentives so that private decision makers will choose to solve the problem
on their own. What name do we use for these types of policies?
ANSWER: We call these policies market-based policies.

33. As a means of dealing with pollution, do economists generally prefer corrective taxes or do they prefer regulations?
ANSWER: Economists generally prefer corrective taxes to regulations.

34. Suppose the Environmental Protection Agency issues pollution permits in order to limit the quantity of pollution.
Under this policy, is the supply of pollution rights perfectly elastic or is it perfectly inelastic?
ANSWER: The supply is perfectly inelastic.

35. What are the three externalities that are associated with driving cars and trucks?
ANSWER: The negative externalities are congestion, accidents, and pollution.

36. A former senator remarked that “We cannot give anyone the option of polluting for a fee.” Do most economists agree
with this statement, or do they disagree with it?
ANSWER: Most economists disagree with this statement.

37. Suppose a new market for tradable pollution permits is created. As long as there is a free market for the pollution
rights, the final allocation will be __________ , regardless of the initial allocation of permits.
ANSWER: efficient

38. Suppose the Environmental Protection Agency uses a corrective tax to set a price for pollution. Under this policy, is
the supply curve for pollution rights vertical or is it horizontal?
ANSWER: The supply curve is horizontal.

39. Some government policies provide incentives for private decision makers to choose to solve the problem of
externalities on their own. What term do we use to describe such policies?
ANSWER: We use the term market-based policies to describe such policies.

40. Suppose a Pigovian tax is imposed on a market that is characterized by one or more externalities. Is this a command-
and-control policy or is it a market-based policy?
ANSWER: A Pigovian tax is a market-based policy.

41. The Environmental Protection Agency (EPA) requires that firms in a certain industry adopt a particular technology to
reduce the emission of pollutants. Is this requirement a command- and-control policy or is it a market-based policy?
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Sec All: Short Answer and Essay (Ch 10)

ANSWER: The requirement that firms adopt a particular technology is a command-and-control policy.

42. Describe the circumstances under which it would be better for the government to sell pollution permits than to levy a
corrective tax.
ANSWER: When the governmental authority (e.g., EPA) wants to restrict the quantity of emissions by a certain amount
but does not know the demand curve for pollution, then it can auction off a certain number of pollution
permits to achieve the desired result. Levying a corrective tax would involve guesswork as to the appropriate
size of the tax.

43. Suppose the government levies a corrective tax on firms that pollute in order to limit the quantity of pollution. Under
this policy, does the demand curve for pollution rights determine the quantity of pollution, or does it determine the price
of pollution?
ANSWER: With a corrective tax, the demand curve for pollution rights determines the quantity of pollution.

44. Suppose the government issues a limited number of pollution permits in order to limit the quantity of pollution. Under
this policy, does the demand curve for pollution rights determine the quantity of pollution, or does it determine the price
of pollution?
ANSWER: With pollution permits, the demand curve for pollution rights determines the price of pollution.

45. The likelihood of successful private solutions to problems caused by externalities depends, in part, upon the number of
interested parties. Briefly explain.
ANSWER: When there is a large number of interested parties, coordinating them all to bargain is costly, if not
impossible.

46. Tyler owns a dog and receives a $300 benefit from owning it. Tyler’s neighbor, Liz, incurs a cost of $450 from the
dog’s barking. Suggest a deal between Tyler and Liz that would result in both individuals becoming better off.
ANSWER: Since Liz’s cost exceeds Tyler’s benefit, Liz could offer Tyler some amount of money to get rid of his dog.
Specifically, Liz could offer an amount of money, M, such that $300 < M < $450, and both individuals
would become better off.

47. Beverly owns a rabbit and receives a $600 benefit from owning it. Sometimes Beverly’s rabbit makes its way onto the
lawn of her neighbor, Charles, and eats the vegetables in Charles’ garden. This intrusion by the rabbit costs Charles $400.
Can both individuals become better off if Charles pays Beverly some amount of money to get rid of the rabbit? Explain.
ANSWER: No, since Beverly would require a payment of more than $600 in order to become better off, while Charles
could become better off only if he paid Beverly less than $400.

48. An example of a private solution to externalities is charities. The government encourages this private solution by
allowing ___________ .
ANSWER: tax deductions for charitable donations

49. In some situations, private economic actors cannot solve the problem of externalities among themselves because of
substantial _________ costs.
ANSWER: transaction

50. Which theorem asserts that private economic actors can often solve the problem of externalities among themselves?
ANSWER: The Coase theorem makes this assertion.

51. Using a supply and demand diagram, demonstrate how a negative externality leads to market inefficiency. How might
the government help to eliminate this inefficiency?
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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).

52. 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.

53. Why are Pigovian taxes preferred to regulatory policies as methods to remedy negative externalities?
ANSWER: Pigovian taxes allow markets to coordinate optimal resource allocation. In order for regulations to be
efficient, the government needs detailed information about specific industries, including information about
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Test Bank for Principles of Economics 8th Edition N. Gregory Mankiw

Name: Class: Date:

Sec All: Short Answer and Essay (Ch 10)

the alternative technologies that those industries could adopt. Thus, taxes are likely to mitigate negative
externalities at a lower cost to society.

54. Use a graph to illustrate the quantity of pollution that would be emitted (a) after a corrective tax has been imposed and
(b) after tradable pollution permits have been imposed. Could these two quantities ever be equivalent?
ANSWER:

Yes, these two quantities could be equal. For example, PB could be equal to the amount of the corrective tax.

55. To produce honey, beekeepers place hives of bees in the fields of farmers. As bees gather nectar, they pollinate the
crops in the fields, which increases the yields of these fields at no additional cost to the farmer. What might be a
reasonable private solution to this externality, and how might the solution be reached?
ANSWER: One solution would be to have one person own both the farm fields and the beehives, in which case the
externality is internalized. Another solution would be to have the farmer and beekeeper enter into a contract
so that they can coordinate the number of bee hives and acres of crops to maintain an efficient outcome.

56. The Coase theorem suggests that efficient solutions to externalities can be determined through bargaining. Under what
circumstances will private bargaining fail to produce a solution?
ANSWER: Private parties may fail to bargain to an efficient solution under a variety of circumstances. First, the
transaction costs of bargaining may be so high that one or both of the parties decides not to bargain. Second,
the bargaining may not take place if one or both of the parties believes that the agreement cannot be
enforced. Third, one or both of the parties may try to hold out for a better deal, in which case the bargaining
process breaks down. Fourth, if there are a large number of parties taking part in the negotiations, the costs of
coordination may be so great that the bargaining is not successful.

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