Deck 21: Externalities in Competitive Markets

Question 1

Explain how a pollution tax is different from a Pigouvian tax.Discuss how incentives for firms differ under the two types of taxes,and what would be required of the government if it were to structure a Pigouvian tax system to mimic the effects of a pollution tax.

Answer 1

A pollution tax imposes a tax on each unit of pollution that is emitted as a firm produces.A Pigouvian tax is a per-unit tax on the good that is being produced.In a particular market,a pollution tax can be set to result in the same decrease in output as an efficient Pigouvian tax -- but the pollution tax gives an incentive for firms to implement pollution abating technologies in production,whereas the Pigouvian tax gives no such incentive unless the government keeps re-setting the Pigouvian tax each time a firm implements pollution abating technologies.

Question 2

When set correctly,a Pigouvian tax is efficient because it is equivalent to a lump sum tax.

Answer 2

False
A lump sum tax does not change relative prices.A Pigouvian tax does change relative prices -- to bring the externality-distorted market price in line with what the price would be if the supply curve arose from the social rather than the private marginal cost curve.

Question 3

In order for a Pigouvian subsidy to be efficient,the amount it costs the government to implement the subsidy must be less than the economic value of the additional externality benefits created by the subsidy.

Answer 3

False
This is not true because there are other benefits produced by the subsidy -- i.e.the additional consumer and producer surplus.

Question 4

In order for a cap-and-trade system to work,it must be that pollution permits are bought by producing firms -- and not given to them as part of an attempt to prevent them to lobby against the cap-and-trade system

Question 5

Explain why many fishermen on a commonly owned lake continue to fish until the revenue from the average catch is equal to the marginal cost of fishing -- and why the same is not true for a firm that employs fishermen to fish on a privately owned lake.

Question 6

It the marginal social benefit from contributions to charities is the same for all individuals who give to charities,then allowing individuals to deduct charitable contributions from their income taxes cannot serve as a Pigouvian subsidy under a progressive income tax system.

Question 7

The Coase Theorem implies that the reason people sue each other in court is that transactions costs are too high.

Question 8

In order for a Pigouvian tax to be efficient,the amount of revenue raised plus the economic value of the reduction in pollution must together be larger than the loss in consumer and producer surplus.

Question 9

According to the Coase Theorem,so long as property rights are established and transactions costs are low,plaintiffs in court cases involving externalities will not care which way a judge decides.

Question 10

In the absence of the negative externality from each individual's contribution to road congestion,roads would not be congested (aside from congestion caused by accidents).

Question 11

If the government does not know the efficient level of a Pigouvian tax to correct for a negative production externality,efficiency will still be enhanced so long as the government imposes a per-unit tax.

Question 12

To implement an efficient Pigouvian tax in a competitive market that has negative production externalities,the government would need to know the shape of the entire social marginal cost curve.

Question 13

Explain how any cap-and-trade system can be made to be equivalent to a pollution tax and vice versa.

Question 14

The more price elastic the demand curve,the more a competitive market will over-produce (relative to the efficient level)in the presence of a negative externality.

Question 15

Regardless of whether a negative externality is emitted by consumers or by producers,a Pigouvian tax can be imposed on consumers only.

Question 16

If a tax on gasoline is appropriately set,the congestion externality on roads can be fully internalized -- resulting in the efficient level of congestion on roads.

Question 17

Whether or not production is accompanied by an externality,a social planner who aims to maximize social surplus will always produce (assuming he does produce)where marginal social cost is equal to marginal social benefit.

Question 18

The Coase Theorem implies that the reason people sue each other in court is that property rights have not been sufficiently well specified.

Question 19

If a positive externality is caused by producers,a Pigouvian subsidy would have to be given to producers; and if a positive externality is caused by consumers,a Pigouvian subsidy would have to given to consumers.

Question 20

Explain how the introduction of an additional competitive market can always solve the efficiency problem that emerges from a negative externality.

Question 21

One condition for the first welfare theorem to hold is that there are no externalities.Can this condition be re-phrased as "all property rights have been established"? And how does this justify a wide range of what we see government doing?

Question 22

Explain how the introduction of an additional competitive market can always solve the efficiency problem that emerges from a positive externality.

Question 23

Suppose you and I are identical.We put up fireworks in our adjacent backyards on a national holiday,and we can both enjoy each other's fireworks.
a.Can you identify an externality?
b.Can you identify any missing markets?
c.Do you think we will provide more or less than the efficient number of fireworks?
d.If we could vote on a tax to be imposed on us fund fireworks in our back yards,would we vote for a lump sum tax (imposed equally on both of us)that will cause more fireworks to be put up than what we would put up on our own?
e.Suppose instead the government implements a Pigouvian subsidy.How would the number of fireworks compare to what would happen in (d)? How much of a subsidy would you think we would both get for every dollar of fireworks each of us individually buys?