Resolving Externalities

Question 1

Command and Control

Answer 1

Setting limits to production or telling firms what technology to use; Need not reduce it to 0

Question 2

What is a problem with setting limits?

Answer 2

Some fit the strict limits, others forced to shut down; Does not allow for firms to seek a better solution

Question 3

Pigovian Tax

Answer 3

Setting a tax equal to the unit cost externality; Producer pays for cost of his actions

Question 4

How does the pigovian tax work?

Answer 4

Sets private and social costs equal by shifting private cost left

Question 5

What is the problem with the pigovian tax?

Answer 5

Hard to figure out what the appropriate tax is

Question 6

Cap and Trade

Answer 6

Limiting overall level of pollution by issuing vouchers allowing firms to produce

Question 7

How does cap and trade work?

Answer 7

Firms can buy and sell vouchers; Inefficient buy, efficient sell, environmentalists buy

Question 8

The Invariance Principle

Answer 8

Markets direct resources to the most productive uses; Affects who pays who; Determined by well-defined property rights and low transactions cost

Question 9

Give an example of well defined property rights

Answer 9

A broadway show puts up sign that puts cafe in shade; If the cafe has property rights, the show chooses the cheapest solution

Question 10

What is the main problem with the invariance principle?

Answer 10

Issue if there are not well-defined property rights, if there are large transactions costs, and if there are income effects that prevent payments