# Essentials of Economics Study Set 12

## Quiz 10 :Externalities

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Which of the following is an example of a positive externality?
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Positive externality:
Positive externality is a benefit that arises from production or consumption that availed by someone who is not a producer or consumer. Hence, the benefits will go to the third person without paying for it.
Earning income by performing a service will not be benefitted to a third person who is not involved in the activity. Hence, there will be no externality from this service.
Neighbors have to breathe smoke if a person mows lawn as the lawnmower spews out smoke. This will cause the neighbors to feel uncomfortable. Hence, the act of cleaning mob will give negative externality.
A person cuts his/her lawn and makes it more attractive to the neighbors staying around. Hence, it will give positive externality.
Neighbors of Mrs. H are willing to pay her if she promises to get her loan cut regularly and maintain clean. Since the neighbors are paying for this service, it does not give positive externality.
Hence, the option 'c' is incorrect.

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Greater consumption of alcohol leads to more motor vehicle accidents and, thus, imposes costs on people who do not drink and drive. a. Illustrate the market for alcohol, labeling the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output. b. On your graph, shade the area corresponding to the deadweight loss of the market equilibrium. (Hint: The deadweight loss occurs because some units of alcohol are consumed for which the social cost exceeds the social value.) Explain.
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(a)
Alcohol presents a negative externality. Because it leads to more motor vehicle accidents and, thus, imposes costs on people who do not drink and drive. The figure below illustrates alcohol market and social optimum.
In the presence of a negative externality, such as accidents, the social cost of the alcohol exceeds the private cost. The optimal quantity, Q optimum , is therefore smaller than the equilibrium quantity Q market.
(b)
The deadweight loss is illustrated by the triangle area "aEb" in the figure below. E is the market equilibrium point. "a" is the social cost corresponding to the excess consumption of Q market. This cost is higher than the social value, described by demand curve. The area "aEb" describes the total amount of social cost exceeding the social value. Only at Q optimum can we minimize the difference between social cost and social benefit. The distance between Q optimum and Q market is over-consumption.
The graph is as follows:

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If the production of a good yields a negative externality, then the social-cost curve lies ___________ the supply curve, and the socially optimal quantity is ___________ than the equilibrium quantity.
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Social cost curve:
Social cost refers to the cost of producing a commodity that is not only bear by the producer but also by the entire society. The social cost is the sum of private cost and external cost.
If a negative externality is the result of producing a good, then the social-cost curve will be above the supply curve. As a result, the socially optimal quantity will be less than the equilibrium quantity.
Hence, the option 'b' is correct.

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When the government levies a tax on a good equal to the external cost associated with the good's production, it ___________ the price paid by consumers and makes the market outcome ___________ efficient.
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Which of the following statements about corrective taxes is NOT true?
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Give an example of a negative externality and an example of a positive externality.
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List some of the ways that the problems caused by externalities can be solved without government intervention.
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The government auctions off 500 units of pollution rights. They sell for $50 per unit, raising total revenue of$25,000. This policy is equivalent to a corrective tax of ___________ per unit of pollution.
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Imagine that you are a nonsmoker sharing a room with a smoker. According to the Coase theorem, what determines whether your roommate smokes in the room? Is this outcome efficient? How do you and your roommate reach this solution?
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The Coase theorem does NOT apply if
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Consider the market for fire, extinguishers. a. Why might fire extinguishers exhibit positive externalities? b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve. c. Indicate the market equilibrium level of out-put and the efficient level of output. Give an intuitive explanation for why these quantities differ. d. If the external benefit is $10 per extinguisher, describe a government policy that would result in the efficient outcome. Essay Answer: Tags Choose question tag In what way does the patent system help society solve an externality problem? Essay Answer: Tags Choose question tag A local drama company proposes a new neighborhood theater in San Francisco. Before approving the permit, the city planner completes a study of the theater's impact on the surrounding community. a. One finding of the study is that theaters attract traffic, which adversely affects the community. The city planner estimates that the cost to the community from the extra traffic is$5 per ticket. What kind of an externality is this? Why? b. Graph the market for theater tickets, labeling the demand curve, the social-value curve,the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output. Also show the perunit amount of the externality. c. Upon further review, the city planner uncovers a second externality. Rehearsals for the plays tend to run until late at night, with actors, stagehands, and other theater members coming and going at various hours. The planner has found that the increased foot traffic improves the safety of the surrounding streets, an estimated benefit to the community of $2 per ticket. What kind of externality is this? Why? d. On a new graph, illustrate the market for theater tickets in the case of these two externalities. Again, label the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, the efficient level of output, and the per-unit amount of both externalities. e. Describe a government policy that would result in an efficient outcome. Essay Answer: Tags Choose question tag Many observers believe that the levels of pollution in our society are too high. a. If society wishes to reduce overall pollution by a certain amount, why is it efficient to have different amounts of reduction at different firms? b. Command-and-control approaches often rely on uniform reductions among firms. Why are these approaches generally unable to target the firms that should undertake bigger reductions? c. Economists argue that appropriate corrective taxes or tradable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should undertake bigger reductions? Essay Answer: Tags Choose question tag Draw a supply-and-demand diagram to explain the effect of a negative externality in production. Essay Answer: Tags Choose question tag The many identical residents of Whoville love drinking Zlurp. Each resident has the following willingness to pay for the tasty refreshment: a. The cost of producing Zlurp is$1.50, and the competitive suppliers sell it at this price. (The supply curve is horizontal.) How many bottles will each Whovillian consume? What is each person's consumer surplus? b. Producing Zlurp creates pollution. Each bottle has an external cost of $1. Taking this additional cost into account, what is total surplus per person in the allocation you described in part (a)? c. Cindy Lou Who, one of the residents of Whoville, decides on her own to reduce her consumption of Zlurp by one bottle. What happens to Cindy's welfare (her consumer surplus minus the cost of pollution she experiences)? How does Cindy's decision affect total surplus in Whoville? d. Mayor Grinch imposes a$1 tax on Zlurp. What is consumption per person now? Calculate consumer surplus, the external cost, government revenue, and total surplus per person. e. Based on your calculations, would you support the mayor's policy? Why or why not?
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Ringo loves playing rock-'n'-roll music at high volume. Luciano loves opera and hates rock-'n'-roll. Unfortunately, they are next-door neighbors in an apartment building with paper-thin walls. a. What is the externality here? b. What command-and-control policy might the landlord impose? Could such a policy lead to an inefficient outcome? c. Suppose the landlord lets the tenants do whatever they want. According to the Coase theorem, how might Ringo and Luciano reach an efficient outcome on their own? What might prevent them from reaching an efficient outcome?
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What are corrective taxes? Why do economists prefer them to regulations as a way to protect the environment from pollution?
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