Review 6 Difficult Cases for the Market, and the Role of Government

Question 1

Economic efficiency

Answer 1

A situation that occurs when 1) all activities generating more benefit that cost are undertaken and 2) no activities are undertaken for which the cost exceeds the benefit.

Question 2

Externalities

Answer 2

Spillover effects of an activity that influences the well-being of non-consenting parties.

Question 3

External costs

Answer 3

Spillover effects that reduce the well-being of non-consenting parties.

Question 4

External benefits

Answer 4

Spillover effects that generate benefits for non-consenting parties.

Question 5

Public goods

Answer 5

Goods for which rivalry among consumers is absent and exclusion of non-paying customers is difficult.

Question 6

Free rider

Answer 6

A person who receives the benefit of a good without paying for it. Because it is often virtually impossible to restrict the consumption of public goods to those who pay, these goods are subject to free-rider problems.

Question 7

Repeat-purchase item

Answer 7

An item purchased often by the same buyer.

Question 8

Negative externalities

Answer 8

Occur when an individual or firm making a decision does not have to pay the full cost of the decision. The cost to society is greater than the cost consumers are paying for it.

Question 9

Positive externalities

Answer 9

Exist when an individual or firm making a decision does not receive the full benefit of the decision. The benefit to the individual or firm is less than the benefit to society.

Question 10

Non-rival in consumption

Answer 10

making the good available to one consumer does not reduce its availability to others.

Question 11

Non-excludable

Answer 11

it is impossible (or at least very costly) to exclude non-paying customers from receiving the good.

Question 12

The economically efficient amount is the ____________ amount of the good.

Answer 12

optimal

Question 13

What is the economically efficient amount of pollution?

Answer 13

The amount at which preventing more pollution has the same cost as the benefit of the pollution already produced.

Question 14

In cases where there is a lack of competition in a market, does the market produce more or less than the economically efficient amount of the product?

Answer 14

less

Question 15

In cases of negative externalities, does the market produce more or less than the economically efficient amount of the product?

Answer 15

more

Question 16

What policies could potentially reduce the problem of negative externalities?

Answer 16

taxing the good or service

Question 17

Assume that the widget market produces an external cost. What is the appropriate tax to correct for this market failure?

Answer 17

A tax sufficient to account for the externality and bring production quantity to the optimum level.

Question 18

In cases of positive externalities, does the market produce more or less than the economically efficient amount of the product?

Answer 18

less

Question 19

What policies could potentially reduce the problem of positive externalities?

Answer 19

subsidize the product or service
having the government provide the product or service

Question 20

Can private markets produce public goods?

Answer 20

yes, but usually at a lower than optimum quantity

Question 21

In cases of public goods, does the market produce more or less than the optimal amount of the product?

Answer 21

less

Question 22

What policies could potentially reduce the problem of public goods?

Answer 22

subsidize the product or service
having the government provide the product or service

Question 23

How do you figure out the optimum amount of a good when there is a negative externality given Quantity, Buyers’ Price, Sellers’ Price, and Marginal External Costs?

Answer 23

Add the Marginal External Costs to the Sellers’ Price, then find the new equilibrium quantity.

Question 24

How do you figure out the optimum amount of a good when there is a positive externality given Quantity, Buyers’ Price, Sellers’ Price, and Marginal External Benefits?

Answer 24

Add the Marginal External Benefit to the Buyers’ Price, then find the new equilibrium quantity.

Question 25

How do you figure out the optimum amount of a public good given Quantity, a number of Buyers’ individual Marginal Benefit and the Sellers’ Price?

Answer 25

Add all buyers’ marginal benefit together and compare to the sellers’ price.

Question 26

What is the appropriate tax rate to correct a market failure due to a negative externality?

Answer 26

Add a tax equal to the marginal external cost to each unit of the good. (it is not possible to accurately measure the marginal external cost)

Question 27

What is the appropriate government response to correct a market failure due to a positive externality?

Answer 27

Subsidize the product at a level equal to the marginal external benefit. (it is not possible to accurately measure the marginal external benefit)

Question 28

How do you figure out how many widgets would tend to be produced in a free market, assuming that there is a free rider in this market?

Answer 28

Add the willingness to pay of all non-free riders and compare it to the sellers’ price.

Question 29

What is the Coase theorem?

Answer 29

If trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.

Question 30

Assume that the net benefit to the polluter of emitting a ton of air pollution into the air equals $80 and the cost of the damage of this pollution equals $100, rights to the air are assigned and can be traded, and bargaining costs for the rights to air are insignificant. According to the Coase theorem, if the air polluter owns the rights to pollute the air, will this ton of pollution be emitted into the air?

Answer 30

No, because those harmed by the pollution would pay the polluter more not pollute (or to buy rights to the air) than the polluter could get from polluting.

Question 31

Assume that the net benefit to the polluter of emitting a ton of air pollution into the air equals $80 and the cost of the damage of this pollution equals $100, rights to the air are assigned and can be traded, and bargaining costs for the rights to air are insignificant. According to the Coase theorem, if the victim of the air pollution owns the rights to pollute the air, will this ton of pollution be emitted into the air?

Answer 31

No, because the polluter would have to pay more for the rights to pollute the air than they would benefit from polluting the air.