Chapter 10

Question 1

EXTERNALITY

Answer 1

Question 2

A RECAP OF WELFARE ECONOMICS

Answer 2

Question 3

NEGATIVE EXTERNALITIES IN PRODUCTION

Answer 3

Question 4

POSITIVE EXTERNALITIES IN PRODUCTION

Answer 4

Question 5

NEGATIVE EXTERNALITIES IN CONSUMPTION

• The social value is less than the private value.
• The planner would want to lower the quantity produced and consumed to QOptimum.

Answer 5

POSITIVE EXTERNALITIES IN CONSUMPTION

• The social value is greater than the private value.
• The planner would want to increase the quantity produced and consumed to QOptimum

Question 6

PRIVATE SOLUTIONS TO EXTERNALITIES

Answer 6

1/ Sometimes the problem of externalities is
solved by moral codes and social sanctions.

Exp: Most people choose not to litter simply because it is the wrong thing to do.

2/ Many charities are established to deal with externalities.

Exp: Private individuals and corporations sometimes sponsor scholarships and prizes for university students, in part because education has positive externalities for
society.

Question 7

Coase theorem

Answer 7

Coase theorem is the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

For example, the Coase theorem suggests that
a contract between the apple grower and the
beekeeper can solve the problem of too few
trees and too few bees. The contract can
specify the number of trees, the number of
bees and perhaps a payment from one party
to the other.

Question 8

WHY PRIVATE SOLUTIONS DO NOT ALWAYS WORK

Answer 8

Sometimes the interested parties fail to solve an externality problem because of transaction costs – the costs that parties incur in the process of agreeing and following through on a bargain.

Question 9

COMMAND-AND-CONTROL POLICIES: REGULATION

Answer 9

• The government can remedy an externality by either requiring or forbidding certain activities.
• *Exp:** it is a crime to dump poisonous chemicals into the water supply.
• Alternatively, the environmental regulator can dictate a maximum level of pollution that factories may emit, or require firms to adopt a particular technology.

Difficulties: include that the regulator needs to know the details about specific industries and about the alternative technologies that those industries could adopt. This information is often difficult for government regulators to obtain.

Question 10

MARKET-BASED POLICIES

Answer 10

• The government can use market-based policies to align private incentives with social efficiency.
• The government can use market-based policies to align private incentives with social efficiency.

- Difficulties include that the government must be able to determine the magnitude of the externality.

Question 11

CORRECTIVE TAXES AND SUBSIDIES

Answer 11

The government can internalise externalities by taxing activities that have negative externalities and subsidising activities that have positive externalities.

An ideal corrective tax = the external cost
from an activity + negative externalities

An ideal corrective subsidy = the external benefit from an activity + positive externalities.

Question 12

TRADEABLE POLLUTION PERMITS

Answer 12

• Another way to internalise the externality is to
  issue tradeable pollution permits.
• Each permit allows a firm to emit a unit of pollution, effectively limiting the country’s total emissions.
• A firm’s willingness to pay for the right to
  pollute, in turn, will depend on its cost of
  reducing pollution: the more costly it is for a
  firm to cut back on pollution, the more it will be
  willing to pay for a permit.

Question 13

EQUIVALENCE OF CORRECTIVE TAXES AND POLLUTION PERMITS

Answer 13