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

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

b. "A negative production externality calls for a Pigovian tax on producers, whereas a negative consumption externality calls for a Pigovian tax on consumers."

2. Consider the market for fire extinguishers.

a. Why might fire extinguishers exhibit positive externalities in consumption?

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 $10 per extinguisher, describe a government policy that would result in the efficient outcome.

3. Contributions to charitable organizations are deductible under the federal income tax. In what way does this government policy encourage private solutions to externalities?

4. Ringo loves playing rock and roll music at high volume. Luciano loves opera and hates rock and 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 them from reaching an efficient outcome?

5. 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 why this policy might be efficient?

6. Greater consumption of alcohol 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 curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output.

b. On your graph, shade the area corresponding 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 economy are too high.

a. If society wishes to reduce overall pollution by a certain amount, why is it efficient to have different amounts of reduction at different firms?

b. Command-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 Pigovian taxes or tradable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should undertake bigger reductions?

8. 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 $10 for Acme and $100 for Creative. The local government wants to reduce overall pollution from 200 tons to 50 tons.

a. If the government knew the cost of reduction for each firm, what reductions would it impose to reach its overall goal? What would be the cost to each firm and the total cost to the firms together?

b. In a more typical situation, the government would not know the cost of pollution reduction at each firm. If the government decided to reach its overall goal by imposing uniform reductions on the firms, calculate the 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 for each firm, is there still some way for it to reduce pollution to 50 tons at the total cost you calculated in part (a)? Explain.

9. Figure 10-5 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 Pigovian tax or by setting a quantity with pollution permits. Suppose there is a sharp improvement in the technology for controlling pollution.

a. Using graphs similar to those in Figure 10-5, illustrate the effect of this development on the demand for pollution rights.

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

10. Suppose that the government decides to issue tradable permits for a certain form of pollution.

a. Does it matter for economic efficiency whether the government distributes or auctions the permits? Does it matter in any other ways?

b. If the government chooses to distribute the permits, does the allocation of permits among firms matter for efficiency? Does it matter in any other ways?

11. The primary cause of global warming is carbon dioxide, which enters the atmosphere in varying amounts from different countries but is distributed equally around the globe within a year. In an article in The Boston Globe (July 3, 1990), Martin and Kathleen Feldstein argue that the correct approach to global warming is "not to ask individual countries to stabilize their emissions of carbon dioxide at current levels," as some have suggested. Instead, they argue that "carbon dioxide emissions should be reduced in countries where the costs are least, and the countries that bear that burden should be compensated by the rest of the world."

a. Why is international cooperation necessary to reach an efficient outcome?

b. Is it possible to devise a compensation scheme such that all countries would be better off than under a system of uniform emission reductions? Explain.

12. Some people object to market-based policies to reduce pollution, claiming that they place a dollar value on cleaning our air and water. Economists reply that society implicitly places a dollar value on environmental cleanup even under command-and-control policies. Discuss why this is true.

13. (This problem is challenging.) There are three industrial firms in Happy Valley.

Initial Cost of Reducing

Firm Pollution Level Pollution by 1 Unit

A 70 units $20

B 80 25

C 50 10

The government wants to reduce pollution to 120 units, so it gives each firm 40 tradable pollution permits.

a. Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation?

b. How much higher would the costs of pollution reduction be if the permits could not be traded?

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