Question 1

For the efficient level of output to be produced, marginal

Accepted Answer

The efficient level of output is achieved when the benefit (marginal private benefit) of producing one more unit of output equals the marginal social cost (cost to society) of producing that same unit. Therefore, the best choice is D, which states that the benefit (marginal private benefit) must equal the marginal social cost for the efficient level of output to be produced. Choices A, B, and C are incorrect because they either do not consider the cost to society or do not account for the externality associated with the production of the good.

Question 2

Suppose that you rent a house next to a factory. The factory legally emits a chemical into the air that smells like feet. You now have to spend $300 more per month on air fresheners because the firm pollutes the air. You could move to another house far enough away from the factory, but the rent for that house is $200 more than you now pay. The efficient solution to this problem is that

Accepted Answer

Moving to the new house is the most efficient solution as the additional rent on that new house is less than the additional expenses you incur from living next to the factory. It saves $100 per month ($300 additional expense - $200 additional rent) and also provides a better living environment. Option A and C are not efficient solutions because they put the burden on the factory owner for something that is legally allowed. Option D is not an ethical solution as pollution harms not just one person but the environment as a whole.

Question 3

If there are external costs of production and firms do not have to account for these costs, then the firms will ________ and ________ compared with the efficient values.

Accepted Answer

If firms do not have to account for external costs, they will produce more than the socially efficient level (overproduce) and sell their goods at a lower price than the efficient value (underprice). This is because the external costs are not reflected in the price of the good and the firm does not bear the full cost of production. Therefore, choice C is the correct answer.

Question 4

When the government taxes a firm that generates external costs, the firm will produce

Accepted Answer

When the government taxes a firm that generates external costs, the tax increases the costs of production for the firm. To continue maximizing profits, the firm will need to adjust their production level. Since the external costs are no longer being fully externalized due to the tax, the firm will decrease the production level so that the marginal cost (which now includes the tax) equals the marginal revenue. This means that the firm will produce fewer units of output than before the tax was imposed.

Question 5

Taxes on a producing firm's spillovers

Accepted Answer

Taxes on a producing firm's spillovers are not meant to eliminate the output entirely or as a way to measure spillovers more easily. Instead, they serve as a way to encourage firms to consider the full costs of their actions, including any negative externalities they impose on others. The taxes can also help deter firms from engaging in activities with negative spillover effects by making it more expensive to do so. While the revenue generated from the taxes can be used to compensate victims of the externality, this is not the primary purpose of the taxes.

Question 6

The Coase theorem states that

Accepted Answer

The Coase theorem states that, under certain conditions (such as low transaction costs and well-defined property rights), private parties can negotiate and arrive at an efficient solution to externalities without government intervention.

Question 7

For the Coase theorem to apply, all of the following conditions must be satisfied EXCEPT:

Accepted Answer

The Coase theorem does not require liability rules to be established and enforced; it focuses on the ability of parties to negotiate without transaction costs.

Question 8

If a tax is imposed on externality-producing activities by perfectly competitive firms so that the market is producing the efficient level of output, then

Accepted Answer

When a tax is imposed to correct for an externality, the price (P) equals the marginal social cost (MSC), and the marginal damage cost (MDC) is greater than zero, reflecting the external cost being internalized.

Question 9

When a perfectly competitive firm weighs price and marginal cost and no externalities exist, it is weighing the full benefits to ________ of additional production against the full costs to ________ of that production.

Accepted Answer

In a perfectly competitive market without externalities, the price reflects the value to buyers (society's benefit) and the marginal cost reflects the cost to sellers (society's cost). Therefore, when a firm weighs price against marginal cost, it is comparing the full benefits to society against the full costs to society.

Question 10

Education generates external benefits. When these external benefits are not considered, the market will produce

Accepted Answer

Education generates external benefits such as a more educated populace leading to higher economic growth, lower crime rates, and better health outcomes. When these external benefits are not considered, the market will produce less than the efficient level of education as the private benefits of education, such as higher wages, are not enough to incentivize individuals to obtain the optimal level of education. Therefore, government intervention is necessary to ensure that education is provided at the socially optimal level.

Question 11

If a tax is placed on perfectly competitive firms that impose external costs on society, the firm's marginal cost curve will shift ________ and the industry supply curve will shift to the ________.

Accepted Answer

If a tax is placed on firms that impose external costs on society, the cost of production for the firms will increase. This will cause the marginal cost curve to shift up. In addition, the tax will cause a decrease in supply, leading to a leftward shift of the industry supply curve. Therefore, the correct answer is D, as it reflects an upward shift in the marginal cost curve and a leftward shift in the industry supply curve.

Question 12

Refer to Scenario 16.1 below to answer the questions that follow.
SCENARIO 16.1: The marginal benefit for a particular food is described by MB = 30 - q,
where q refers to the quantity of the food. The marginal cost of producing the food is described by MC = 2q. There is a negative externality associated with food production and the marginal social cost of food production is MSC = 4q.
-Refer to Scenario 16.1. The efficient output level is ________ and the efficient price is ________.

Accepted Answer

To find the efficient output level, set the marginal benefit (MB) equal to the marginal social cost (MSC): 30 - q = 4q. Solving for q gives q = 6. To find the efficient price, substitute q = 6 into the MC or MSC equation (since they should be equal at the efficient point), giving MC = 2(6) = 12 or MSC = 4(6) = 24. The correct efficient price is based on the MSC, so it's $24.

Question 13

When the government imposes a tax on a firm that generates external costs, the tax is

Accepted Answer

When the government imposes a tax on a firm that generates external costs, the tax is usually borne by both the firm and the consumer. The firm may pass on some of the tax to consumers by increasing prices, but will also try to reduce the externality to avoid paying the tax. Thus, both the firm and the consumer will end up sharing the burden of the tax.

Question 14

Once a firm is made to internalize a negative externality, the price will

Accepted Answer

When a negative externality is internalized, the firm will face additional costs for the harmful effects it is causing to society. This will increase its costs, which in turn will lead to an increase in price. Since the firm now has to pay for the external costs, it will also produce less output than it would have otherwise in order to minimize its costs. Hence, the correct answer is that the price will increase and output will decrease (option A).

Question 15

If a subsidy is granted to perfectly competitive firms that provide external benefits to society, the firm's marginal cost curve will shift ________ and the industry supply curve will shift to the ________.

Accepted Answer

When a subsidy is granted to firms, it effectively lowers their cost of production, which is represented by a downward shift in the marginal cost curve. Since the firms can now produce at a lower cost, they are willing to supply more at each price level, which shifts the industry supply curve to the right.

Question 16

An external cost is

Accepted Answer

An external cost is the cost imposed on a third party that is not directly involved in the transaction or activity. It is equal to the difference between the marginal social cost (MSC) and the marginal private cost (MC). Therefore, the correct formula is MSC - MC, making option B the best choice.

Question 17

If private bargaining to resolve an externality is to result in an efficient outcome,

Accepted Answer

If the initial assignment of rights is clear to both parties, they can bargain to reach an efficient outcome without the need for additional regulations or tradable permits. This is known as the Coase theorem. However, if property rights are not clearly assigned or protected, liability rules may be necessary to encourage efficient outcomes. Tradable pollution rights and direct regulation of externalities may also be effective in certain situations, but overall a clear assignment of rights is the most important factor for efficient private bargaining.

Question 18

If the production of a good generates external benefits, the government could increase efficiency by

Accepted Answer

When a good generates external benefits, it means that the benefits are not fully captured by the producers and consumers involved in the transaction. In this case, the government could increase efficiency by subsidizing the production of the good to increase the amount produced, which would lead to a larger overall benefit to society. By providing a subsidy, the government can help to ensure that producers are more likely to take the positive externalities into account when making their production decisions, thereby increasing the amount of the good produced and the benefits it generates for society as a whole.

Question 19

You spend $300 every month to keep your lawn and garden maintained. Your neighbor has told you that she derives $50 a month in enjoyment from being able to look at your beautiful yard. Which of the following is true?

Accepted Answer

The efficient level of lawn maintenance would be greater than $300 a month if we take into consideration the benefits that the neighbor derives. This is because the neighbor's enjoyment is a positive externality, which is a benefit to a third party that is not considered in the monetary cost of the lawn maintenance. Therefore, the efficient level would be higher than what the homeowner would choose if only considering personal costs and benefits.

Question 20

Property rights are protected by

Accepted Answer

Property rights are protected through the use of injunctions and liability rules. These legal tools ensure that individuals are held accountable for any damages or harm caused to the property of others. Additionally, these tools can be used to prevent others from infringing upon an individual's property rights. Taxes and subsidies (A) have little direct impact on property rights, while bargaining and negotiation (B) are more effective in resolving disputes related to the use or allocation of property, rather than protecting property rights themselves. Rivalry and excludability (D) are characteristics of goods, and are not directly related to the protection of property rights.

Quiz 16: Externalities, Public Goods, and Social Choice