Chapter 11

Question 1

External costs (negative externality)

Answer 1

A cost of an activity that falls on people other than those who pursue the activity

Question 2

External benefit (positive externality)

Answer 2

A benefit of an activity received by people other than those who pursue the activity

Question 3

What do externalities cause?

Answer 3

Reduce economic efficiency

Question 4

What are the solutions to externalities

Answer 4

Solutions to externalities may be efficient

Government intervention or other collective action may be effective when efficient solutions to externalities are not possible

Question 5

No externality and resource allocation

Answer 5

The optimal level of an activity for the individual is the socially optimal level of the activity

Question 6

Positive externality

Answer 6

The level of the activity will be less than the socially optimal level

Question 7

Negative externality

Answer 7

The level of the activity will be higher than the socially optimal level

Question 8

Effect of inefficiency on externalities

Answer 8

The situation can be rearranged in a way that would make some people better off without harming others

Question 9

The Coase (1960, Nobel prize 1991) theorem

Answer 9

If trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome.

Question 10

The ‘tragedy of the commons’

Answer 10

The tendency for a resource that has no price to be used until its marginal benefit falls to zero

One person’s use of the commons imposes an external cost on the others by making the property less valuable