Final Exam - Econ 318 || A+ Verified Already.
Externalities correct answers An externality occurs whenever actions taken by firms or
consumers impose costs or confer benefits on others that are not involved in the transaction
(third party effects) without any reimbursement for the cost or a charge for the benefit involved
Examples of externalities correct answers Examples of Negative Externalities: a free market
produces too much of a harmful good that is socially
undesirable
Automobile exhaust
Cigarette smoking
Barking dogs (loud pets)
Loud stereos in an apartment building
Dangerous driving due to alcohol consumption
Examples of Positive Externalities: a free market produces too little of a useful good that is
socially desirable
Immunizations
Restored historic buildings
Research into new technologies
Education
allocatively efficient outcome correct answers If the two sides to an externality — the one
causing it and the one suffering it — can bargain together, they will produce the allocatively
efficient outcome
When transactions costs are excessive, we may
,- Accept the externality and learn to live with it, or
-Governments may intervene on our behalf to deal with it
Negative Externalities in Production correct answers The intersection of the demand curve and
the social-cost curve determines the optimal output level.
The socially optimal output level is less than the market equilibrium quantity.
The social costs of production are higher than the private cost to producers and consumers.
To internalize a negative externality: Impose a tax on the producer to reduce the equilibrium
quantity to the socially desirable quantity
Positive Externalities in Production correct answers The intersection of the demand curve and the
social-cost curve determines the optimal output level.
The social costs of production are less than the private cost to producers and consumers.
ex: new tech spillover
To internalize a positive externality: Offer a subsidy to the producer to reduce his cost and
increase the equilibrium quantity to the socially desirable quantity
Negative Externalities in Consumption correct answers The intersection of the social value curve
and the supply curve determines the optimal output level.
The social value of consumption of a good is lower than the private value to consumers.
ex: alcohol
,To internalize a negative externality: Impose stiff fines for alcohol abuse to reduce the
equilibrium quantity to the socially desirable quantity
Positive Externalities in Consumption correct answers The intersection of the social value curve
and the supply curve determines the optimal output level.
The social value of consumption of a good is higher than the private value to consumers.
ex: education
To internalize a positive externality: Subsidize education through student loans, bursaries, and
scholarships to increase the equilibrium quantity to the socially desirable quantity
Socially Optimal Output correct answers Internalizing an externality involves altering incentives
so that people take into account the external effects of their actions.
The government can internalize an externality in production by trying to shift the supply to either
reduce or increase the equilibrium quantity to reach the socially desirable quantity.
To internalize a negative externality: Impose a tax on the producer to reduce the equilibrium
quantity to the socially desirable quantity
To internalize a positive externality: Offer a subsidy to the producer to reduce his cost and
increase the equilibrium quantity to the socially desirable quantity
The government can internalize an externality in consumption by trying to shift the demand to
either reduce or increase the equilibrium quantity to reach the socially desirable quantity.
, To internalize a negative externality: Impose stiff fines for alcohol abuse to reduce the
equilibrium quantity to the socially desirable quantity
To internalize a positive externality: Subsidize education through student loans, bursaries, and
scholarships to increase the equilibrium quantity to the socially desirable quantity
Public Policy towards Pollution correct answers When externalities are significant and private
solutions are not found, government may attempt to control pollution through . . .
A. Command-and-Control Policies
Usually take the form of regulations:
Forbid certain behaviors (ban throwing untreated sewage in the river)
Require certain behaviors (requirement that all students be immunized)
B. Market-Based Policies
Government uses taxes and subsidies to align private incentives with social efficiency. In the
case of pollution, the government can
Place a price on the pollution through Pigovian taxes
Taxes enacted to correct the effects of a negative externality.
Place a limit on the amount of pollution through issuing tradable pollution permits and allow the
voluntary transfer of the right to pollute from one firm to another.
A market for these permits will eventually develop.
A firm that can reduce pollution at a low cost may prefer to sell its permit to a firm that can
reduce pollution only at a high cost.
Externalities correct answers An externality occurs whenever actions taken by firms or
consumers impose costs or confer benefits on others that are not involved in the transaction
(third party effects) without any reimbursement for the cost or a charge for the benefit involved
Examples of externalities correct answers Examples of Negative Externalities: a free market
produces too much of a harmful good that is socially
undesirable
Automobile exhaust
Cigarette smoking
Barking dogs (loud pets)
Loud stereos in an apartment building
Dangerous driving due to alcohol consumption
Examples of Positive Externalities: a free market produces too little of a useful good that is
socially desirable
Immunizations
Restored historic buildings
Research into new technologies
Education
allocatively efficient outcome correct answers If the two sides to an externality — the one
causing it and the one suffering it — can bargain together, they will produce the allocatively
efficient outcome
When transactions costs are excessive, we may
,- Accept the externality and learn to live with it, or
-Governments may intervene on our behalf to deal with it
Negative Externalities in Production correct answers The intersection of the demand curve and
the social-cost curve determines the optimal output level.
The socially optimal output level is less than the market equilibrium quantity.
The social costs of production are higher than the private cost to producers and consumers.
To internalize a negative externality: Impose a tax on the producer to reduce the equilibrium
quantity to the socially desirable quantity
Positive Externalities in Production correct answers The intersection of the demand curve and the
social-cost curve determines the optimal output level.
The social costs of production are less than the private cost to producers and consumers.
ex: new tech spillover
To internalize a positive externality: Offer a subsidy to the producer to reduce his cost and
increase the equilibrium quantity to the socially desirable quantity
Negative Externalities in Consumption correct answers The intersection of the social value curve
and the supply curve determines the optimal output level.
The social value of consumption of a good is lower than the private value to consumers.
ex: alcohol
,To internalize a negative externality: Impose stiff fines for alcohol abuse to reduce the
equilibrium quantity to the socially desirable quantity
Positive Externalities in Consumption correct answers The intersection of the social value curve
and the supply curve determines the optimal output level.
The social value of consumption of a good is higher than the private value to consumers.
ex: education
To internalize a positive externality: Subsidize education through student loans, bursaries, and
scholarships to increase the equilibrium quantity to the socially desirable quantity
Socially Optimal Output correct answers Internalizing an externality involves altering incentives
so that people take into account the external effects of their actions.
The government can internalize an externality in production by trying to shift the supply to either
reduce or increase the equilibrium quantity to reach the socially desirable quantity.
To internalize a negative externality: Impose a tax on the producer to reduce the equilibrium
quantity to the socially desirable quantity
To internalize a positive externality: Offer a subsidy to the producer to reduce his cost and
increase the equilibrium quantity to the socially desirable quantity
The government can internalize an externality in consumption by trying to shift the demand to
either reduce or increase the equilibrium quantity to reach the socially desirable quantity.
, To internalize a negative externality: Impose stiff fines for alcohol abuse to reduce the
equilibrium quantity to the socially desirable quantity
To internalize a positive externality: Subsidize education through student loans, bursaries, and
scholarships to increase the equilibrium quantity to the socially desirable quantity
Public Policy towards Pollution correct answers When externalities are significant and private
solutions are not found, government may attempt to control pollution through . . .
A. Command-and-Control Policies
Usually take the form of regulations:
Forbid certain behaviors (ban throwing untreated sewage in the river)
Require certain behaviors (requirement that all students be immunized)
B. Market-Based Policies
Government uses taxes and subsidies to align private incentives with social efficiency. In the
case of pollution, the government can
Place a price on the pollution through Pigovian taxes
Taxes enacted to correct the effects of a negative externality.
Place a limit on the amount of pollution through issuing tradable pollution permits and allow the
voluntary transfer of the right to pollute from one firm to another.
A market for these permits will eventually develop.
A firm that can reduce pollution at a low cost may prefer to sell its permit to a firm that can
reduce pollution only at a high cost.
