Quiz 17: Interdependence and the Gains From Trade

EXTERNALITIES Complete each of the following sentences: a. Resources that are available only in a fixed amount are _______ resources. b. The possibility that a open-access resource is used until the marginal value of additional use equals zero is known as the _______. c. Resources for which periodic use can be continued indefinitely are known as _______ resources.

RESOLVING THE COMMON-POOL PROBLEM Why have authorities found it so difficult to regulate the fishing catch in the open ocean to allow for a sustainable yield?

OPTIMAL LEVEL OF POLLUTION Explain the difference between fixed-production technology and variable technology. Should the government set a goal of reducing the marginal social cost of pollution to zero in industries with fixed-production technology? Should they do so in industries with variable technology?

Case Study: Destruction of the Tropical Rainforests Why does a solution to the overharvesting of timber in the tropical rainforests require some form of international cooperation? Would this be a sufficient solution to the deforestation problem?

THE COASE THEOREM Suppose a firm pollutes a stream that has a recreational value only when pollution is below a certain level. If transaction costs are low, why does the assignment of property rights to the stream lead to the same (efficient) level of pollution whether the firm or recreational users own the stream?

THE COASE THEOREM Ronald Coase points out that a market failure does not arise simply because people ignore the external cost of their actions. What other condition is necessary? What did Coase consider to be an efficient solution to a negative externality?

Four federal laws and subsequent amendments underpin U.S. environmental protection. Identify these laws.

Case Study: BP's Oil Spill in the Gulf Should the government require deep water oil companies to spend whatever it takes to reduce the chance of future spills to zero? Reference Case Study: Public Policy BP's Oil Spill in the Gulf On April 20, 2010, the Deepwater Horizon oil rig exploded in the Gulf of Mexico in a drilling accident that killed 11 workers and hospitalized many. Both BP and the government initially underestimated the size of the spill, and neither had a response plan in place. Though the oil industry had experienced blowouts at shallower depths, an accident a mile down was new and devastating. Federal regulators seemed lax prior to the accident, perhaps captives of the industry. The size of the Gulf spill combined with live video of the gushing well and photos of oil-soaked birds marked this tragedy in the public's mind. President Obama called it the worst environmental disaster in U.S. history. The explosion and resulting oil spill, accidental byproducts of BP's efforts to supply oil, threatened the livelihood of tens of thousands around the Gulf and could impose lasting damage on the habitat. BP spent billions on cleanup in the first three months, but that was peanuts compared to the costs company owners have and will face. More than 150 class-action lawsuits named BP as a defendant. Hoping to attract more clients, law firms purchased domain names such as offshoreinjuries.com and bigoilspills.com and advertised with billboards along the Gulf Coast. Environmental groups filed suits of their own. President Obama warned BP against "nickel and diming" the economic victims of the accident. And the Justice Department opened a criminal probe against BP for possible violations of the Clean Water Act and other environmental laws. Here's a question: Was this oil spill a negative externality? Was this an unpriced by product that affected neither buyer nor seller but third parties? The buyers in this case were customers for BP gasoline and the seller was BP. Market competition may make it difficult for BP to pass along its spill-related costs, so BP consumers may not be much affected. How about BP? If this were truly an externality, then the accident would have had little impact on the supplier, BP, or the company BP hired to drill the well, Transocean. But both have been profoundly affected. Because BP has been reviled by everyone from President Obama on down, the company's brand name will be tarnished for a generation, becoming the poster child of polluters in the public's mind, in the media, even in textbooks. Lawsuits will likely cost the company billions and may take years to settle (some Exxon-Valdez suits from the 1989 Alaska spill took more than two decades to resolve). For its part, Transocean, the owners of the rig, saw 11 workers die in the explosion and many more hospitalized. The drilling rig itself, which cost Transocean $375 million, sank two days after the explosion. Although lawsuits may be in the courts for years, share owners of BP and Transocean didn't have to wait long to see their losses reflected in stock prices. Within six weeks of the accident, the share price of each company sank 50 percent. In BP's case, that meant a loss in the market value of the company of about $90 billion. Because Transocean was a smaller company, its market value fell about $15 billion. Although the exact amount of the spill may never be known, let's say the total turns out to be about 200 million gallons, a figure higher than any reported estimate. This would imply that BP and Transocean stockholders together lost more than $500 in market value for each of the 200 million gallons of crude oil spilled into the Gulf. There remained some question whether the companies will survive. For example, BP established a $20 billion fund to compensate those affected by the spill. The company was forced to sell rights to some oil fields to pay for the cleanup and was expected to issue bonds to raise more money. No question, many in the Gulf region have been harmed by the spill, and some of the damage could last for years. But many people will be compensated for their losses. The legal system, the government, the media, and the stock market have placed much of the cost of this accident squarely on BP and Transocean, and to that extent, most of what otherwise would have been external costs became internalized.

POSITIVE EXTERNALITIES The value of a home depends in part on how attractive other homes and yards in the neighborhood are. How do local zoning ordinances try to promote land uses that generate external benefits for neighbors?

EXTERNAL COSTS WITH FIXED-PRODUCTION TECHNOLOGY Review the situation illustrated in Exhibit 1 in this chapter. If the government sets the price of electricity at the socially optimal level, why is the net gain equal to triangle abc , even though consumers now pay a higher price for electricity? What would the net gain be if the government set the price above the optimal level?

NEGATIVE EXTERNALITIES Suppose you wish to reduce a negative externality by imposing a tax on the activity that creates it. When the amount of the externality produced per unit of output increases as output increases, the correct tax can be determined by using a demand-supply diagram; show this. Assume that the marginal private cost curve slopes upward.

EXTERNAL COSTS Use the data in the next table to answer the following questions. a. What is the external cost per unit of production? b. What level is produced if there is no regulation of the externality? c. What level should be produced to achieve economic efficiency? d. Calculate the dollar value of the net gain to society from correcting the externality.

EXTERNAL COSTS WITH VARIABLE TECHNOLOGY Think of an industry that pollutes the water and has access to variable technology for reducing that pollution. Graphically illustrate and explain the impact of each of the following, other things constant, on the optimal level of water quality for a given rate of output: a. New evidence is discovered about a greater risk of cancer from water pollution. b. The cost of pollution-control equipment increases. c. A technological improvement reduces the cost of pollution control.

MARKET FOR POLLUTION RIGHTS The following graph shows the market for pollution rights. a. If there are no restrictions on pollution, what amount is discharged? b. What is the quantity supplied and the quantity demanded if the government restricts the amount of discharge to Q * but gives the permits away? c. Where is market equilibrium if the government sells the permits? Illustrate this on the graph. d. What happens to market equilibrium if the government reduces the amount of discharge permitted to Q ** ? Illustrate this on the graph. e. How could an environmental group ensure a lower rate of discharge than that chosen by public officials?

Login to www.cengagebrain.com and access the Global Economic Watch to do this exercise. Global Economic Watch and Case Study: Destruction of the Tropical Rainforests Go to the Global Economic Crisis Resource Center. Select Global Issues in Context. In the Basic Search box at the top of the page, enter the phrase "carbon ranching." On the Results page, go to the Global Viewpoints Section. Click on the link for the June 16, 2007, editorial "Home on the Rainforest." Is the program described an example of command-and-control environmental regulation or of the economic efficiency approach?

Login to www.cengagebrain.com and access the Global Economic Watch to do this exercise. Global Economic Watch Go to the Global Economic Crisis Resource Center. Select Global Issues in Context. Go to the menu at the top of the page and click on the tab for Browse Issues and Topics. Choose Environment and Climate Change. Choose one of the topics listed and read the overview for that topic. Analyze the marginal social benefit and marginal social cost involved in your chosen topic.