Micro Topic 6.

2
Externalities
Part 1 – Check Your Understanding​-​ Read the following passage from the National Fire Protection
Association regarding consumer fireworks and answer the questions below.
“Fireworks start an average of 18,500 fires per year, including 1,300 structure fires, 300 vehicle
fires, and 16,900 outside and other fires. These fires caused an average of three deaths, 40
civilian injuries, and an average of $43 million in direct property damage.” ​(www.nfpa.org)
1. Fully explain why consumer fireworks can be considered an example of a negative externality.

2. When the government is not involved, is the market price for consumer fireworks higher, lower, or
equal to the socially optimal price? Explain.

3. Identify two different government policies that could reduce fires and injuries caused by fireworks.

4. In 2017, the state of Pennsylvania imposed an additional 12% sales tax on consumer fireworks.
Identify one specific behavior that could limit this policy’s effectiveness in preventing fires and
injuries.

Part 2 – Graph It​-​ The graph below shows an unregulated market for high powered consumer fireworks.
Assume that each box of fireworks generates $40 of external costs on society and that the demand
equals the marginal social benefit.
5. Identify the equilibrium price and quantity
produced by the unregulated market.

6. Add a marginal social cost (MSC) curve to

the graph and identify the socially optimal
price and quantity.

7. At the quantity of 50 boxes of fireworks,

shade in the area of deadweight loss.

8. Assume that the demand for fireworks

suddenly became more inelastic. Would the
deadweight loss that results from the
unregulated market increase, decrease, or
stay the same? Explain.

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 Micro Topic 6.2
Externalities
9. Assume that the government imposes a $20 per unit tax on fireworks. Does this policy eliminate
deadweight loss? Explain.

10. Assume instead that the government bans fireworks. Does this eliminate deadweight loss? Explain.

Part 3 - Making Connections​- ​Read the following and use the graph to answer the questions.
“...with processed food and sweetened drinks becoming household staples. Even very low-income
communities are seeing rising rates of obesity, diabetes, cancer, and heart disease....There are
immense costs, in terms of lost productivity, lost wages, increased health expenditures, and a smaller
labor force....To tackle this health crisis, a new task force of well-known academics and advocates is
encouraging developing nations to treat candy and soft drinks as many of them treat alcohol and
cigarettes -and to tax them….”
[ Lowrey, Annie. “More Taxes and Less Death?” ​The Atlantic​, Jan. 25, 2018.]

The graph to the right shows the market for

soda with the marginal social benefit (MSB),
marginal private benefit (MPB), and marginal
social cost (MSC).
11. Calculate the per unit dollar value of the
external cost when 30,000 cases of soda
are produced.

12. Calculate the per unit dollar value of the

external cost when 40,000 cases of soda
are produced.

13. Calculate the per unit dollar value of the

external cost when 50,000 cases of soda
are produced.

14. The MSC is often drawn parallel to the MPC

but in most real-world situations the MSC
increases at a faster rate. Using the
example of soda, explain why the per unit
external cost increases as more cases are produced.

15. Explain why it is difficult to accurately calculate the external cost of soda in the real-world.

16. Do you think that the government should regulate and tax soda like they do alcohol and cigarettes?
Fully explain your opinion.

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 Micro Topic 6.2
Externalities
Part 1 – Check Your Understanding​-​ Read the following passage from the Centers for Disease
Control and Prevention regarding flu shots and answer the questions below.
“...​Recent studies show that flu vaccination reduces the risk of flu illness by between 40% and
60% among the overall population...flu ​vaccine prevents millions of illnesses and flu-related
doctor’s visits each year. For example, during 2016-2017, flu vaccination prevented an
estimated 5.3 million influenza illnesses, 2.6 million influenza-associated medical visits, and
85,000 influenza-associated hospitalizations.” ​(​www.cdc.gov​)
1. Fully explain why flu shots can be considered an example of a positive externality.

2. When the government is not involved, is the market quantity of flu shots higher, lower, or equal to
the socially optimal quantity? Explain.

3. In addition to saving money on medical visits and hospitalizations, identify two additional external
economic benefits of flu shots.

Part 2 - Graph It​- ​Graph the marginal private benefit (MPB), marginal social benefit (MSB), and
marginal social cost (MSC) for flu shots using the data in the table below, then answer the questions.

4. Identify the price and quantity

produced by the unregulated
market.

5. Identify the socially optimal price and quantity and shade in the area of deadweight loss.

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 Micro Topic 6.2
Externalities
6. Assume that the government gives consumers a $0.40 per unit subsidy for flu shots, does this
policy eliminate deadweight loss? Explain.

7. Assume instead that the government gives producers a $0.80 per unit subsidy for flu shots, does
this policy eliminate deadweight loss? Explain.

8. Calculate the total dollar amount the $0.80 per unit subsidy from question #6 would cost. Explain
how you got your answer.

9. Rather than providing a subsidy, identify a different policy the government could use to achieve the
socially optimal outcome.

Part 3 - Making Connections​- ​The graph below shows the market for smoke alarms with the marginal
social benefit (MSB), marginal private benefit (MPB), and marginal social cost (MSC).
10. Assume your friend says that installing a
smoke alarm in her house results in a
positive externality because the alarm
can save her life if there was a fire. Fully
explain why this is not an example of a
positive externality.

11. Calculate the per unit value of the

external benefit when 20,000 units are
produced

12. Calculate the per unit value of the

external benefit when 40,000 units are
produced.

13. Explain why the external benefit of

smoke alarms increases as more units
are produced.

14. Calculate the area of deadweight loss at the free market price and quantity.

15. Calculate the area of deadweight loss at the socially optimal price and quantity.

16. Calculate the per unit dollar amount the government could subsidize consumers to achieve the
allocatively efficient outcome. Explain how you got your answer.

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