Lecture 3

Question 1

What is the socially optimum state?

Answer 1

The socially optimal state is reached when the difference between the aggregate costs and the aggregate
utility is maximized. This means that the maximum possible utility over all individuals is achieved, with the
minimum of costs.

Question 2

What does the Coase theorem State?

Answer 2

The misallocation can be solved if the actors negotiate with each other, and
property rights exist. Who owns the property rights and to what extent is irrelevant. In every case of
distribution of property rights, an improvement can be expected.

Question 3

What types of externalities are there?

Answer 3

Positiv production
positive consumption
Negative Production
Negative Consumption

Question 4

What is a Negative Production externality?

Answer 4

When a firm’s production reduces the well-being of others who are not
compensated by the firm.
 Pollution from steel production, dumped in a river, hurts fishermen.

Question 5

Negative Consumption Externality

Answer 5

When an individual’s consumption reduces the well-being of others
who are not compensated by the individual.
 Smoking at a restaurant affects the health and enjoyment of others

Question 6

What is Private Marginal Costs?

Answer 6

The direct cost to producers of producing an additional unit of a good.

Question 7

What is Social Marginal Cost?

Answer 7

The private marginal cost to producers plus any costs associated with the
production of the good that are imposed on others.

Question 8

What is Private and social Marginal Benefit?

Answer 8

Private marginal benefit (PMB): The direct benefit to consumers of consuming an additional unit of a
good by the consumer.
* Social marginal benefit (SMB): The private marginal benefit to consumers minus any costs associated
with the consumption of the good that are imposed on others.`

Example:
The loss of health or dining pleasure is a cost of smoking imposed on others.

Question 9

Problem of Coasian Theorem

Answer 9

The assignment problem:
The first problem is assigning blame. Does the fisherman pay the steel plant for not polluting? Or does the steel plant pay for polluting?

The holdout problem:
Shared ownership of property rights gives each owner power over all the others. Each person has veto power and so may demand enormous payments

The free rider problem:
When an investment has a personal cost but a common benefit, individuals will underinvest. Individuals may not want to pay enough to reduce pollution.

Transaction costs and negotiating problems:
It is hard to negotiate when there are large numbers of individuals on one or both sides of the negotiation.

Question 10

Advantages of certificates

Answer 10

• The maximum amount of pollutants is fixed in advance
• The possibility to sell certificates creates incentives to avoid negative externalities
• Even for very profitable companies the maximum amount of externalities is fixed
• Precise quantity control
• Ecological accuracy
• Dynamic incentive effect
• Adjustment of the quantity of certificates

Question 11

Difficulties of Pigouvian Tax

Answer 11

• The curve runs must be known precisely for the respective industry.
• The social costs incurred are determined by the damage, which is very difficult to determine and assess.
• With an increasing number of polluters and injured parties, correct tax rates are almost impossible to
  determine precisely.
• The same applies to Pigou subsidies, but here usually no precise quantity limit is defined.

Question 12

Quantity Regulation when there are several plants

Answer 12

For each plant, the marginal cost of pollution reduction is set equal to the marginal social
benefit of that reduction.

Question 13

Corrective Tax when there are several plants

Answer 13

Pigouvian taxes induce efficient production by increasing the cost of the input by the amount
of its external damage.

Question 14

Quantity Regulation with tradable Permits when there are several plants

Answer 14

Trading allows the market to account for differences in pollution
reduction costs across firms.

Question 15

What is the difference between Price and Quantity regulation when there are multiple plants with different reduction costs

Answer 15

Quantity regulation ignores the fact that plants have different marginal costs of reducing pollution.
Pigouvian taxes lead to efficient production by increasing the cost of inputs by the amount of external
damage, raising marginal private costs to social marginal costs.
Taxes are preferable to quantity regulation, which distributes reductions evenly across plants, because taxes
give plants more flexibility in choosing their optimal level of reductions and allow them to choose the efficient
level.

Question 16

Summarize wether price or quantity regulation is better.

Answer 16

Which of these methods leads to the most efficient regulatory outcomes depends on factors such as the heterogeneity of the firms being regulated, the flexibility associated with quantity regulation, and uncertainty about the costs of reducing externalities.

Question 17

When is smoking an externality

Answer 17

Health Care Costs:
(how is the gov. setting up its health insurance)
- Not if the indv. pays for the healthcare
- Yes if the indv. is in public healthcare and others have to take over the costs.

Set Fires:
-Not if the indv. burns own stuff and pays for the firebregade
- Yes if they burn other ppls stuff and ppl have to pay for the firemen

Workplace productivity:
- Not If ppl are paid on productivity
- Yes if people get paid while they are taking more breaks

Death Benefit:
- Not if we dont have to pay 4 them when they are old
- Yes because they dont pay taxes anymore once they are dead!

Question 18

Second Hand Smoking. Is it an Externality?

Answer 18

Secondhand smoke: Tobacco smoke inhaled by individuals in the vicinity of smokers.
The costs of secondhand smoke are not easily added to the list of external costs:
* There is considerable medical uncertainty about the damage done by secondhand smoke.
* Most of the damage from secondhand smoke is delivered to the spouse and children of smokers.