ECON 101 Study Guide - Final Guide: High Tech, Pigovian Tax, Coase Theorem

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Econ101 Chapter 16 Reading Notes

An externality occurs when individuals impose costs or deliver benefits to others but

don’t have an economic incentive to consider those costs/benefits when making decisions

One of the principle sources of market failure is actions that create externalities

Negative externalities are side effects that impose costs on others

Whenever a side effect can be observed and quantified, it can be regulated: by imposing

direct controls on it, taxing it, or subsidizing it

External cost: an uncompensated cost that an individual or firm imposes on others

External benefit: a benefit that an individual or firm confers on others without receiving

compensation; external costs and benefits are externalities

External costs-negative externalities; external benefits- positive externalities

Externalities can lead to private decisions by individuals/firms that are not optimal for

society; we assume that amount of pollution emitted is directly observable/controllable

Marginal social cost of pollution: additional cost imposed on society as a whole by an additional

unit of pollution

Typically marginally social cost of pollution is increasing

Each additional unit of pollution emitted causes a greater level of damage

Marginal Social Benefit of Pollution: additional gain to society as a whole from an additional

unit of pollution; would be goods/services that could be had by society if there was another unit

of pollution; Pollution can be reduced at a cost

Avoiding pollution requires using scarce resources that could have been employed to

produce other goods/ services

MSB of pollution= goods and services that could be had by society with more pollution

Socially Optimal Quantity of Pollution: quantity of pollution that society would choose if all the

costs and benefits of pollution were accounted for

Marginal social cost usually slopes up-typically increasing

Marginal social benefit curve- downward sloping

At high levels of pollution, it is cheaper to achieve a reduction in pollution

As pollution levels drop, it becomes progressively more costly

A market economy, left to itself, will not arrive at the socially optimal quantity

While pollution yields costs and benefits, in a market economy w/o government

intervention too much pollution will be produced

The market outcome is inefficient- mutually beneficial trade is being missed

Externalities in a market economy cause inefficiency: there is a mutually beneficial trade

that is being missed

Coase Theorem: even in the presence of externalities, an economy can always reach an efficient

solution as long as transaction costs- the costs to individuals of making a deal are low

If costs are sufficiently low, drillers/landowners can make a mutually beneficial deal

When individuals take externalities into account when making decisions, economists say

they internalize the externality- in that case the outcome can be efficient w/o intervention

Problems that stop individuals from internalizing the externality are the high cost of

communication and the high cost of making legally binding and timely agreement

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ECON 101 Full Course Notes

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An externality occurs when individuals impose costs or deliver benefits to others but don"t have an economic incentive to consider those costs/benefits when making decisions. One of the principle sources of market failure is actions that create externalities. Negative externalities are side effects that impose costs on others. Whenever a side effect can be observed and quantified, it can be regulated: by imposing direct controls on it, taxing it, or subsidizing it. External cost: an uncompensated cost that an individual or firm imposes on others. External benefit: a benefit that an individual or firm confers on others without receiving compensation; external costs and benefits are externalities. External costs-negative externalities; external benefits- positive externalities. Externalities can lead to private decisions by individuals/firms that are not optimal for society; we assume that amount of pollution emitted is directly observable/controllable. Marginal social cost of pollution: additional cost imposed on society as a whole by an additional unit of pollution.

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home / study / business / economics / questions and answers / Question 1 Which Of The Following Is The Best Example ... Question: Question 1 Which of the following is the best exam... Bookmark Question 1 Which of the following is the best example of a positive externality? A car company lays off 10,000 employees in order to cut costs. An individual drives a large SUV, which increases the amount of greenhouse gases in the atmosphere. An individual smokes in a restaurant, which bothers other patrons. A child is vaccinated against a disease, which reduces the probability that other children will catch the disease. 4 points Question 2 As a result of a negative externality, the market equilibrium quantity is too ______ compared to the socially optimal quantity. As a result of a positive externality, the market equilibrium quantity is too ______ compared to the socially optimal quantity. high; high. low; low. high; low. low; high. 4 points Question 3 Based on the diagram below, the deadweight loss area associated with the market equilibrium equals: Week06_graph1.jpg $10 $50 $80 $1,000 4 points Question 4 A firm's accounting profit is given by total revenue: less implicit costs. less explicit costs. less economic profit. less implicit and explicit costs. 4 points Question 5 Suppose an activity has a private cost equal to $30 and a private benefit equal to $30. The associated social cost equals $35 and the social benefit equals $30. Which of the following statements is true about this activity? There is a negative externality associated with this activity but not a positive externality. There is a positive externality associated with this activity but not a negative externality. There is both a positive and a negative externality associated with this activity. There is neither a positive nor a negative externality associated with this activity. 4 points Question 6 The Coase Theorem implies that: the efficient level of an externality is generally zero. private individuals living in market economies should not be concerned with externalities. government intervention is not always needed to arrive at the efficient level of an externality. government laws are unnecessary. 4 points Question 7 An industry in which a small number of large firms sell products that are either close or perfect substitutes is: perfectly competitive. monopolistically competitive. an oligopoly. a monopoly. 4 points Question 8 When a negative externality is present in a market: a tax can increase the level of economic surplus. the social benefits are greater than the private benefits. there is generally too little of the good produced by private markets. the government should ensure that there are zero external costs associated in all markets. 4 points Question 9 In the presence of a positive externality, the government can arrive at the socially optimal output level by: paying producers a subsidy equal to the amount of social benefits associated with the activity. charging producers a tax equal to the amount of social costs associated with the activity. paying producers a subsidy equal to the amount of external benefits associated with the activity. charging producers a tax equal to the amount of external costs associated with the activity. 4 points Question 10 The tragedy of the commons is that: too few individuals have access to high quality healthcare. common people overconsume public goods. the quality of life for lower income people is generally lower than that of higher income people. a resource with no price tends to be exploited until its marginal benefit falls to zero. 4 points Question 11 One potential remedy to the tragedy of the commons is to: never allow a single individual to consume more than one percent of the common resource. criminalize the usage of common resources. allow individuals to use a common resource as long as they receive some benefit from doing so. place a common resource under private ownership. 4 points Question 12 As a result of a positional externality: contestants have a tendency to invest in a series of mutually offsetting investments in performance enhancement. there is generally an underinvestment in performance enhancement. the market price of performance enhancement materials is too high. the quality of performance in competitive situations is lower than the socially optimal level. 4 points Question 13 Which of the following statements is true regarding health insurance? Economics shows that all health related procedures should be free to individuals because the health of an individual is priceless. Total economic surplus would be larger if individuals faced an incentive to only use services when the benefit exceeds their costs. Health maintenance organizations provide an incentive for doctors to prescribe expensive nonessential services. First dollar insurance coverage has likely had very little to do with rising healthcare expenditures since World War II. 4 points Question 14 A strategy that yields a higher payoff no matter what the other players in the game choose is known as a: prisoner's strategy. dominated strategy. dominant strategy. Nash strategy.

Question 1:

The annual income that can be consumed without diminishing the total capital assets of a nation is

purchasing power parity income.

sustainable national income.

environmental capital stock.

per capita income.

Question 2:

Maintaining the rainforest is very important because

of its absorptive capacity for CO2 emissions.

of maintaining agricultural production of countries dependent on the rainforest such as Brazil.

ensuring a successful land reform policy.

encouraging rainforest settlement of the poor

Question 3:

Which of the following leads to an underallocation of resources to a specific economic activity?

Question 4:

The free-rider problem plagues public goods because

once public goods are produced it is not possible to exclude anyone from consuming these goods.

the public doesn't care about public goods.

public goods are not produced by profit-maximizing firms and hence can be produced only at a loss to society.

policymakers ignore opportunity costs in making decisions

Question 5:

Which of the following methods could be used to correct for external costs?

Require firms in the industry to install pollution control devices.

Impose a tax or an effluent fee on the offenders.

Have the offender clean up the pollution it caused.

All of the above would be appropriate.

Question 6:

To correct for a negative externality, a government might impose a uniform tax related only to the physical quantity of pollution if

the economic damages are zero.

the administrative costs are high.

the cost of ascertaining the actual economic costs are relatively small.

the economic damages associated with the pollution are different across different locations.

Question 7:

In order to internalize the externality due to pollution, the government should impose a tax based on

the size of the firm causing the pollution.

the physical amount of pollution.

the value of the pollution-causing business activity.

the economic damage associated with the pollution.

Question 8:

In a market for emission permits, firms that emit over their allowed limits

pay a price of these emissions.

are forced to shut down.

are taxed by the government for the amount of emissions.

receive a subsidy for the amount of emissions.

Question 9:

The 1997 Kyoto Protocol was signed by

more than three dozen nations.

all nations in the world.

only the United States and the European Union.

only nations in Asia.

Question 10:

The problem of overfishing in waters that are commonly owned can be solved by

subsidizing fishing.

establishing property rights for fishing in the waters.

the use of the Coase Theorem.

allowing the market to ration fish.

1. The marginal product of labor is:

A. equal to the demand for labor.

B. the payment made to workers for their contribution to the output they produce.

C. the change in a firm's revenue as a result of hiring one more worker.

D. the additional output a firm produces as a result of hiring one more worker.

2. What does the phrase "internalizing an external cost" mean?

A. limiting the extent to which domestic firms can outsource production

B. prohibiting economic activities that create externalities

C. finding a way to address cross-border pollution

D. forcing producers to factor into their production costs the cost of the externalities created in the production of their output

3. The highest-valued alternative that must be given up to engage in an activity is the definition of

A. implicit cost

B. opportunity cost.

C. utility.

D. economic sacrifice.

4. What is market failure?

A. It refers to the inability of the market to allocate resources efficiently up to the point where marginal social benefit equals marginal private cost.

B. It refers to a situation where an entire sector of the economy (for example, the airline industry) collapses because of some unforeseen event.

C. It refers to a breakdown in a market economy because of widespread corruption in government.

D. It refers to the inability of the market to allocate resources efficiently up to the point where marginal social benefit equals marginal social cost.

5. Suppose a competitive firm is paying a wage of $12 an hour and sells its product at $3 per unit. Assume that labor is the only input. If the last worker hired increases output by three units per hour, then to maximize profits the firm should

A. lay off some of its workers.

B. does not change the number of workers it currently hires.

C. hire additional workers.

D. There is not enough information to answer the question.

6. When the price of summer tank tops falls and you buy more of them because they are relatively less expensive, this is called

A. the deadweight loss effect.

B. the income effect.

C. the substitution effect.

D. the elasticity effect.

7. An externality is

A. a benefit realized by the purchaser of a good or service.

B. a benefit or cost experienced by someone who is not a producer or consumer of a good or service.

C. a cost paid for by the producer of a good or service.

D. anything that is external or not relevant to the production of a good or service.

8. Firms pay famous individuals to endorse their products because

A. apparently demand is affected not just by the number of people who use a product but also by the type of person that uses the product. '

B. famous people only consume high-quality products.

C. famous people obviously know what are the best goods and services.

D. the firms are irrational and are wasting advertising expenditures.

9. If a consumer receives 20 units of utility from consuming two candy bars, and 25 units of utility from consuming three candy bars, the marginal utility of the second candy bar is

A. 25 utility units.

B. 20 utility units.

C. 5 utility units.

D. unknown as more information is needed to determine the answer.

10. When there is a negative externality, the private cost of production ________ the social cost of production.

A. is less than

B. is greater than

C. eliminates

D. is equal to

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ECON 101 Study Guide - Final Guide: High Tech, Pigovian Tax, Coase Theorem

ECON 101 Full Course Notes

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