Problems And Applicatio

1. There are two ways to protect your car from theft. The Club makes it difficult for a car thief to take your car. Lojack makes it easier for the police to catch the rar thief who has stolen it. Which of these types of protection conveys a negative externality on other car owners? Which conveys a positive externality? Di> you think there are any policy implications of your analysis?

2. Do you agree with the following statements? Why or why not?

a. "The benefits of corrective taxes asa way to reduce pollution have to be weighed against the deadweight losses that these taxes cause."

b. "When deciding whether to levy a corrective tax on consumers or producers, the government should be careful to levy the lax on the side of the market generating the externality."

3. Consider the market for fire extinguishers.

a. Why might fire extinguishers exhibit positive externalities?

b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve.

c. Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ.

d. If the external benefit is S10 per extinguisher, describe a government policy that would yield the efficient outcome.

4. It is rumored that the Swiss government subsidizes cattle farming and that the subsidy is larger in areas with more tourist attractions. Can you think of a reason this policy mi>;ht be efficient?

5. A local drama company proposes a new neighborhood theater in San Francisco. Before approving the permit, the city planner completes a study of the theater's impact on the surrounding community.

a. One finding of the study is that theaters attract traffic, which adversely affects the community. The city planner estimates that the cost to the community from the extra traffic is 55 per ticket. What kind of an externality is this? Why?

b. Graph the market for theater tickets, labeling lite demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output. Also show the per-unit amount of ihe externality.

c- Upon further review, the city planner uncovers a second externality. Rehearsals for the plays tend to run until late at night, with actors, stagehands, and other theater members coming and going at various hours. The planner has found that the increased foot traffic improves the safety of the surrounding streets, an estimated benefit to tlie community of $2 per ticket. What kind of externality is this? Why7

d. On a new graph, illustrate the market for theater tickets in the case of these two externalities. Again, label the demand curve, the social-value curve, the supply curvc, the social-cost curve, the market equilibrium level of output, Ihe efficient level of output, anil the per-unit amount of both externalities, c. Describe a government policy that would result in an efficient outcome.

6. Greater consumption of akohol leads to more motor vehicle accidents and, thus, imposes costs on people who do not drink and drive.

a. Illustrate the market for alcohol, labeling the demand curve, the social-value curve, the supply cum-, Ihe social-cost curve, Ihe market equilibrium level of output, and the efficient level of output.

b. On your graph, shade the area airresponding to the deadweight loss of the market equilibrium, (Hint; The deadweight loss occurs because some units of alcohol are consumed for which the social cost exceeds the social value.) Explain.

7. Many observers believe that the levels of pollution in our society are too high.

a. If society wishes to n-duce overall pollution by a certain amount, why is it effkknt to have different amounts of reduction at different firms?

b. Cbmmand-and-control approaches often rely on uniform reductions among firms Why are these approaches generally unable to target the firms that should undertake bigger reductions?

c. Economists argue that appropriate corrective taxes or tradable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should undertake bigger reductions?

8. Ringo loves playing rock-'n'-roll musk at high volume- Luciano loves opera and hates i\>ck-'n'-roll. Unfortunately, they are next-door neighbors in an apartment building with paper-thin walls.

a. What is the externality here?

b. What command-and-control policy might the landlord impose? Could such a policy lead to an inefficient outcome?

c. Suppose the landlord lets the tenants do whatever they want. According to the Coase theorem, how might Ringo and Luciano reach an efficient outcome on their own? What might prevent tliem from reaching an efficient outcome?

9. The Pristine River has two polluting firms on its banks. Acme Industrial and Creative Chemicals each dump 100 tons of glop into the river each year. The cost of reducing glop emissions per ton equals S10 for Acme and $100 for Creative. Tl>e local government wants to reduce overall pollution from 200 tons to 50 Ions.

a. If the government knows the cost of reduc-tk>n for each firm, what reductions will it impose lo reach its overall goal? What will be the wst to each firm and the total cost to the firms together?

b. In a more typical situation, the government does not know the cost of pollution reduction for each firm. If the government decides to reach its overall goal by imposing uniform reductions on Ihe firms, calculate Ihe reduction made by each firm, the cost to each firm, and the total cost to the firms together.

c. Compare the total cost of pollution reduction in parts (a) and (b). If the government does not know the cost of reduction fur each firm, is there still some way for it to reduce pollution to 50 tons at the total cost you calculated in pari (a)? Explain.

10. Figure 4 shows that for any given demand curve for the right to pollute, the government can achieve the same outcome either by setting a price with a corrective tax or by setting a quantity with pollution permits. Suppose there is a sharp improvement in the technology for controlling pollution.

a. Using graphs simiLir to those in Figure 4, illustrate the effect of this development on the demand for pollution rights.

b. What is the effect on Ihe price and quantity of pollution under each regulatory system? Explain.

11. Suppose that the government decides to issue tradable permits fur a certain form of pollution.

a. Does it matter for economic efficiency whether the government distributes or auc-tions the permits?

b. If Ihe government chooses to distribute the permits, does the allocation of permits among firms matter for efficiency?

12. There arc three industrial firms in Happy

Valley.

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