UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS

DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

PRACTICE PROBLEMS
EXTERNALITIES
1. There are two plants (A and B) in an industry. To reduce pollution, the government has imposed
environmental standards forcing each plant to cut emissions by 60%. At the emissions standard, the
marginal social benefit of pollution for plant A is $500, and the marginal social benefit of pollution for
plant B is $125. The same level of pollution can be achieved at a lower cost by:
A) forcing plant A to reduce emissions and allowing plant B to increase emissions.
B) allowing plant A to pollute more and plant B to pollute less.
C) forcing both plants to reduce emissions.
D) allowing both plants to pollute more.

Figure: Negative Externalities and Raising Pigs for Pork

2. (Figure: Negative Externalities and Raising Pigs for Pork) Refer to the figure Negative Externalities and
Raising Pigs for Pork. If the marginal external cost of raising a pig for pork is $200, then the socially
optimal quantity of pigs to raise is ________ and the socially optimal price is ________.
A) 150; $900
B) 200; $800
C) 250; $700
D) 300; $800

3. (Figure: Negative Externalities and Raising Pigs for Pork) Refer to the figure Negative Externalities and
Raising Pigs for Pork. If the socially optimal production of pigs is 250, the government could achieve
this socially optimal production by imposing a Pigouvian tax of:
A) $400.
B) $300.
C) $250.
D) $200.

4. The Coase theorem states that in the presence of externalities, a market economy will:
A) always reach an efficient solution.
B) never reach an efficient solution.
C) reach an efficient solution if transaction costs are sufficiently low.
D) reach an efficient solution only in the case of government regulation.

20211208 1 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

Figure: City with Two Polluters

5. (Figure: City with Two Polluters) Look at the figure City with Two Polluters. If the government imposed
an emissions tax of $400, firm A would produce ________ tons of emissions and firm B would
produce ________ tons of emissions.
A) 200; 400
B) 400; 1,200
C) 800; 1,400
D) 1,200; 1,600

6. (Figure: City with Two Polluters) Look at the figure City with Two Polluters. If the government issued
licenses to pollute a total of 1,600 tons of emissions, the market price to emit 1 ton of emissions would
equal:
A) $100.
B) $200.
C) $300.
D) $400.

7. (Figure: City with Two Polluters) Look at the figure City with Two Polluters. If the government wants to
limit total pollution to 2,200 tons, it could impose an emissions tax of ________ on both firms.
A) $100
B) $200
C) $300
D) $400

8. (Table: Pollution and Marginal Cost of Reduction) Look at the table Pollution and Marginal Cost of
Reduction. There are two large firms in your community, Big Chemical and Mega Manufacturing, and
each is a significant source of pollution. Combined, they are producing 500 tons of pollution, and the
EPA has determined that pollution levels should be much lower, 250 tons. The table shows the current
pollution levels for each firm and the marginal cost of reducing pollution for each firm. The marginal
cost is constant.
20211208 2 PRACTICE PROBLEMS: EXTERNALITIES
UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

a) If the EPA dictated that each firm must emit only 125 tons of pollution, how much total cost would
the firms incur to meet this environmental standard?
b) If the EPA distributed 125 pollution permits to each firm, each giving the firm the right to emit one
ton of pollution, which firm will sell pollution permits, and which firm will buy pollution permits?
c) Under this system of pollution permits, what is the total cost to the firms of reducing pollution to
the limit of 250 total tons?

9. Given the general agreement that pollution is undesirable and social welfare is increased by reducing
pollution, the optimal level of pollution in a society is:
A) zero.
B) the level that reduces the marginal social costs of pollution to zero.
C) the level of pollution at which the marginal social cost of pollution is equal to the marginal social benefit
of pollution.
D) the level of pollution that minimizes the average total cost of producing the product that generates the
pollution.

10. The efficient level of pollution is:

A) the quantity at which its total benefits exceed its total costs by the greatest possible amount.
B) the quantity at which its total benefits equal its total costs.
C) where the marginal social benefit of an additional unit of pollution emission is greater than the marginal
social cost of the additional unit of pollution.
D) where the marginal social benefit of an additional unit of pollution emission is less than the marginal
social cost of the additional unit of pollution.

11. According to the Coase theorem, a market will ________when negative externalities are present.
A) always reach an efficient solution
B) reach an efficient solution if transaction costs are low
C) reach an efficient solution only if the government intervenes in the market
D) reach an efficient solution only if the negative externalities are offset by positive externalities

12. (Table: The Socially Optimal Quantity of Flash Drives) The table The Socially Optimal Quantity of
Flash Drives lists several values for price (P), quantity demanded (QD), and quantity supplied (QS) from
the market demand and supply curves for flash drives. Suppose that the production of flash drives
generates a marginal external cost equal to $10. The socially optimal number of flash drives will be:
A) 5.
B) 7.
C) 9.
D) 11.

20211208 3 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

Figure: Environmental Standards versus Emissions Taxes

13. (Figure: Environmental Standards versus Emissions Taxes) In the figure Environmental Standards
versus Emissions Taxes, if the goal is to limit the total emissions of the two firms, A and B, to 600
tons, the most efficient solution is an ________, and total pollution would be ________ tons.
A) environmental standard; 300
B) emissions tax; 600
C) environmental standard; 600
D) emissions tax; 200

14. The marginal social benefit of pollution:

A) is zero, since pollution is not beneficial.
B) can be measured as the additional gain to society from one additional unit of pollution.
C) is easy to estimate, since polluters are required to file this information in their tax returns.
D) is equal to the marginal social cost of pollution, since benefits to producers are equal to costs to
consumers.

15. If the number of available tradable emissions permits is decreased, the equilibrium price of the permits
________ and the equilibrium quantity of emissions ________.
A) decreases; decreases
B) increases; increases
C) increases; decreases
D) decreases; increases

16. Assume the price of a tradable emissions permit for a ton of sulfur dioxide is $150. Which of the
following is incorrect?
A) A firm that buys permits has an incentive to limit pollution up to the point at which the marginal benefit
of emissions is equal to $150.
B) A firm that has more permits than it plans to use has an incentive to limit pollution up to the point at
which the marginal benefit of emissions is equal to $150.
C) The opportunity cost of emitting a ton of sulfur dioxide is $75 for all firms.
D) The opportunity cost of emitting a ton of sulfur dioxide is $150 for all firms.

17. Markets for the right to pollute are:

A) created by individual firms when they reduce pollution emissions.
B) created by government when it issues tradable pollution permits.
C) likely to result in fewer incentives to find and create technology that reduces pollution.
D) a means by which more pollution is encouraged.

20211208 4 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

Figure: Marginal Private Benefits and Marginal Social Benefits

18. (Figure: Marginal Private Benefits and Marginal Social Benefits) One way for the government to achieve
this socially optimal level is by:
A) imposing a per-unit tax equal to P1 – P2.
B) providing a per-unit subsidy of P0 – P2.
C) mandating consumption at output level Q1.
D) leaving the quantity at the initial private market-clearing quantity and price.

19. The difference between the marginal social cost curve and the marginal cost of production curve is the:
A) additional cost of producing an additional good.
B) marginal external cost.
C) producer's supply curve.
D) marginal external benefit.

20. When tradable emissions permits are used, if the demand for goods that produce emissions shifts to the
right, the equilibrium price of permits ________, and the equilibrium quantity ________.
A) falls; increases
B) increases; stays the same
C) falls; falls
D) stays the same; increases

21. Suppose the production of roses generates a positive externality in that travelers enjoy the scenic rural
vistas. Then the market price of roses:
A) is less than the marginal social benefit of roses.
B) is more than the marginal social benefit of roses.
C) equals the marginal social benefit of roses.
D) may be more than, less than, or equal to the marginal social benefit of roses.
Figure: Positive Externalities and the Production of Semiconductor Chips

20211208 5 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

22. (Figure: Positive Externalities and the Production of Semiconductor Chips) Look at the figure Positive
Externalities and the Production of Semiconductor Chips. If the socially optimal production of chips is
500, the government could achieve the socially optimal level of production by granting a Pigouvian
subsidy of:
A) $5.
B) $10.
C) $15.
D) $20.

23. (Figure: Positive Externalities and the Production of Semiconductor Chips) Look at the figure Positive
Externalities and the Production of Semiconductor Chips. If the marginal external benefit of
producing a chip is $10, then the socially optimal quantity of chips is ________ and the socially
optimal price is ________.
A) 200; $20
B) 300; $25
C) 500; $35
D) 600; $20

Scenario: Private and External Benefits

A small community finds that tidy lawns and neighborhoods provide both private and external
benefits. They determine that the marginal private benefit (MPB) of lawns can be represented by the
following equation: MPB = 50 – 0.5Q, where Q is the number of hours spent on keeping lawns tidy.
The marginal private cost (MPC) of such lawn upkeep is represented by the following equation: MPC
= 0.5Q, where Q is again the number of hours engaged in lawn upkeep.
24. (Scenario: Private and External Benefits) Based on the information provided in the scenario Private and
External Benefits, how many hours of lawn upkeep will occur in this community, and what will be the
marginal private benefit of such upkeep?
A) 50 hours; $50
B) 45 hours; $20
C) 50 hours; $25
D) 100 hours; $50

25. (Scenario: Private and External Benefits) Look at the scenario Private and External Benefits. The
community estimates the marginal social benefit from lawn upkeep to be $15. Given this information,
what is the socially optimal amount of lawn upkeep for this community?
A) 0 hours
B) 45 hours
C) 50 hours
D) 65 hours

26. (Scenario: Private and External Benefits) Look at the scenario Private and External Benefits. The
community decides that given all the benefits of lawn upkeep, it is important to maintain the socially
optimal number of lawn upkeep hours. In order to achieve this, the community will:
A) require community lawn service of 45 hours.
B) subsidize everyone who contributes to lawn upkeep with a payment of $15.
C) implement a Pigouvian lawn tax of $65.
D) provide no additional funds to lawn upkeep.

20211208 6 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

27. Industrial production of goods creates pollution that damages the environment. Suppose the marginal
social cost of pollution can be represented by the function MSC = 2T, where T represents tons of
pollution. Suppose the marginal social benefit of pollution can be represented by the function MSB =
1000 – 2T.
a) In an unregulated market, how many tons of pollution will be emitted?
b) Solve for the socially optimal number of tons of pollution.
c) What is the Pigouvian tax that will reduce pollution to the optimal level?

28. A plastics manufacturing plant emits pollution into the Big River. This leads to higher costs and
disruption for fishermen on the river, for which they are not compensated. In this situation:
A) too little of society's resources is being used to produce plastic.
B) too much of society's resources is being used to produce plastic.
C) the ideal amount of society's resources is being used to produce plastic.
D) there is an external benefit to society from plastic production.

29. Economists believe that there are more efficient ways to deal with pollution than with environmental
standards because these standards do not:
A) reduce pollution enough.
B) allow reductions in pollution to be achieved at minimum cost.
C) internalize the externality.
D) provide for any means of enforcement.

30. When farmers raise pigs, there are a number of external costs. In particular, raising pigs generates
methane gas. Without government regulation, the equilibrium price and quantity of pigs raised means
that:
A) too few pigs will be raised.
B) the price will be less than the marginal social cost.
C) the price will be less than the marginal benefit.
D) the price will be less than the marginal cost to pig farmers.

31. Brad and Angelina are neighbors. Brad never mows his yard, rakes his leaves, or trims his hedges. His
overgrown yard is not only an eyesore, it is pulling down the value of Angelina's house. How could the
Coase theorem be used to remedy this negative externality? Does it matter whether Brad has the right
to ignore his yard or whether Angelina has the right to force him to clean it up?
Figure: Three Firms That Pollute

20211208 7 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

32. (Figure: Three Firms that Pollute) Three firms in a small city are responsible for emitting pollution, and
the marginal benefit of the individual polluters is shown in the figure Three Firms That Pollute. If each
company is allowed to emit only 300 tons of pollution per day, which company will be most adversely
affected?
A) firm A
B) firm B
C) firm C
D) They are equally affected.

33. (Figure: Three Firms that Pollute) In the figure Three Firms That Pollute, at what tax rate would firm C
produce zero tons of pollution?
A) $400
B) $500
C) $700
D) $400, $500, or $700

34. (Figure: Three Firms that Pollute) Three firms in a small city are responsible for emitting pollution, and
the marginal benefit of the individual polluters is shown in the figure Three Firms That Pollute. If the
city imposes a tax of $400 per ton of pollution, firm B will produce ________, while firm A will
produce ________ of mercury than firm C.
A) 600 tons; 200 tons less
B) 700 tons; 200 tons less
C) 300 tons; 500 tons more
D) 300 tons; 200 tons less

35. Suppose government officials have set an emissions tax to reduce pollution, whose marginal societal
cost is assumed to be constant. Assume the optimal tax would be $500 but government officials have
set the tax equal to $900. At the equilibrium with the $900 tax:
A) there will be too much pollution.
B) the marginal social cost of pollution will be less than $900.
C) the marginal social benefit of pollution will be $900.
D) the marginal social benefit of pollution will be more than $900.

36. If drivers decide to make phone calls without considering the costs imposed on others, the:
A) number of phone calls made while driving will be more than the socially optimal quantity.
B) number of phone calls made while driving will be fewer than the socially optimal quantity.
C) marginal social cost curve will lie below the marginal cost of production curve.
D) marginal social benefit curve will lie below the marginal social cost curve.

Use the following to answer question 37.

20211208 8 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

37. (Table: The Marginal Social Cost of Batteries) The table The Marginal Social Cost of Batteries lists
several price (P) and quantity (QS) values along the market supply curve for batteries. Because batteries
generate toxic wastes, there is an external cost associated with their production. The marginal external
cost is estimated to be $10. The marginal social cost would then be indicated by the values in the
column labeled:
A) MSC1.
B) MSC2.
C) MSC3.
D) MSC4.

38. The efficient rate of emissions occurs when:

A) there is absolutely no damage done to a pristine environment.
B) government forces zero pollution to take place no matter what the cost.
C) the marginal benefits of pollution exceed the marginal costs of pollution.
D) the change in benefits and the change in costs due to an additional unit of emissions are equal.

39. For the same amount of pollution emitted, an emissions tax is said to be more efficient than an
environmental standard because all polluters:
A) emit pollution up to the point at which the marginal benefit of polluting is equal to the emissions tax.
B) emit the same amount of pollution, regardless of the marginal benefit of polluting.
C) pay the same total tax bill for their pollution.
D) reduce pollution emissions to zero.

40. Oscar owns a meat processing plant whose unpleasant odors waft across the city. Because the
production of processed meat provides a negative externality to the community, at the market
equilibrium quantity, the marginal social:
A) cost of processed meat exceeds the market price.
B) benefit of processed meat exceeds the market price.
C) cost of processed meat is lower than the market price.
D) benefit of processed meat is lower than the market price.

41. When the government attempts to reduce the noise from airplanes by restricting the noise level from a
jet engine to less than 50 decibels, it is using a(n):
A) environmental standard.
B) emissions tax.
C) Pigouvian tax.
D) tradable emissions permit.

42. The marginal external cost of a good or activity equals the amount:
A) by which the marginal social benefit curve is higher than the demand curve.
B) by which the marginal social cost curve is lower than the supply curve.
C) by which the marginal social cost curve is higher than the supply curve.
D) at which the marginal social benefit curve intersects the demand curve.

43. The marginal benefit of pollution emissions ________ as the quantity of pollution emissions ________.
A) decreases; increases
B) increases; increases
C) decreases; decreases
D) remains unchanged; goes up or down
20211208 9 PRACTICE PROBLEMS: EXTERNALITIES
UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

44. An externality is said to be internalized:

A) when individuals take external costs and benefits into account in their decision making.
B) when the Coase theorem is irrelevant or cannot be applied.
C) when individuals successfully petition the government to ban or restrict activities that generate negative
externalities.
D) when individuals learn to adapt to negative externalities through introspection or internal acceptance of
what are viewed as unchangeable facts of life.

20211208 10 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

Answer Key
1. B
2. C
3. D
4. C
5. B
6. D
7. C
8. a) Big Chemical must reduce pollution by 175 tons, so the firm incurs 175 ¥ $8 = $1,400. Mega
Manufacturing must reduce pollution by 75 tons, so the firm incurs 75 ¥ $4 = $300. Total cost of
reducing pollution to 250 tons is $1,700.
b) Big Chemical will buy pollution permits from Mega Manufacturing because it costs Big Chemical
more to reduce pollution than it costs Mega Manufacturing to reduce pollution.
c) If Mega Manufacturing sells all 125 pollution permits to Big Chemical, Mega Manufacturing will
emit zero and thus reduce pollution by a total of 200 tons at a cost of 200 * $4 = $800. Big Chemical
will now have 250 pollution permits, so the firm will still reduce need to pollution by 50 tons at a cost
of 50 * $8 = $400. Total cost of reducing pollution to 250 tons is now $1200.
9. C
10. A
11. B
12. B
13. B
14. B
15. C
16. C
17. B
18. B
19. B
20. B
21. A
22. B
23. C
24. C
25. D
26. B
27. a) Polluters will continue to pollute until MSB = 0. That occurs when T = 500 tons of pollution.
b) The socially optimal quantity is where MSC = MSB, or 2T = 1,000 – 2T, or when T = 250 tons.
c) The amount of tax is the amount that corresponds to the socially optimal quantity of 250 tons. Put
T = 250 into either MSC or MSB and the tax is $500.
28. B
29. B
30. B
31. Angelina's property values are being hurt by Brad's overgrown yard. The Coase theorem would suggest
that Angelina offer Brad payment to clean up his yard. No, it doesn't matter who has the right. If Brad
has the right to keep his yard as overgrown as he wants, then Angelina can pay him to clean it up. If
Angelina has the right to a clean neighborhood and untarnished property values, then Brad can pay her
to avoid mowing the yard.
32. A

20211208 11 PRACTICE PROBLEMS: EXTERNALITIES

UNIVERSITY OF TORONTO ECO101: PRINCIPLES OF MICROECONOMICS
DEPARTMENT OF ECONOMICS ROBERT GAZZALE, PHD

33. D
34. C
35. C
36. A
37. C
38. D
39. A
40. A
41. A
42. C
43. A
44. A

20211208 12 PRACTICE PROBLEMS: EXTERNALITIES