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Chapter 10

Externalities

Educators

SM

Problem 1

Consider two ways to protect your car from theft. The Club (a steering wheel lock) makes it difficult for a car thief to take your car. Lojack (a tracking system) makes it easier for the police to catch the car thief who has stolen it. Which of these methods conveys a negative externality on other car owners? Which conveys a positive externality? Do you think there are any policy implications of your analysis?

Kaylee M.
Numerade Educator

Problem 2

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 output 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 yield the efficient outcome.

Kaylee M.
Numerade Educator

Problem 3

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.

Kaylee M.
Numerade Educator

Problem 4

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?

Kaylee M.
Numerade Educator

Problem 5

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?

Yi Chun L.
Washington University in St Louis

Problem 6

Bruno loves playing rock 'n' roll music at high volume. Placido 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 Bruno and Placido reach an efficient outcome on their own? What might prevent them from reaching an efficient outcome?

Kaylee M.
Numerade Educator

Problem 7

Figure 4 shows that for any given demand curve for the right to pollute, the government can achieve the same outcome either by setting a price with a corrective tax or by setting a quantity with pollution permits. Suppose there is a sharp improvement in the technology for controlling pollution.
a. Using graphs similar to those in Figure 4, illustrate the effect of this development on the demand for pollution rights.
b. What is the effect on the price and quantity of pollution under each regulatory system? Explain.

Kaylee M.
Numerade Educator

Problem 8

Suppose that the government decides to issue tradable permits for a certain form of pollution.
a. Does it matter for economic efficiency whether the government distributes or auctions the permits?
Why or why not?
b. If the government chooses to distribute the permits, does the allocation of permits among firms matter for efficiency? Explain.

Kaylee M.
Numerade Educator

Problem 9

There are three industrial firms in Happy Valley.
The government wants to reduce pollution to 60 units, so it gives each firm 20 tradable pollution permits.
a. Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation?
b. How much higher would the costs of pollution reduction be if the permits could not be traded?

Yi Chun L.
Washington University in St Louis