Externalities, Public Goods and Common-Pool Resources Problem Set

Microeconomics & Macroeconomics

1. An externality is
A. a benefit realized by the purchaser of a good or service.
B. a cost paid for by the producer of a good or service.
C. a benefit or cost experienced by someone who is not a producer or consumer of a good or
service.
D. anything that is external or not relevant to the production of a good or service.

2. What is a market failure?

A. It refers to the inability of the market to allocate resources efficiently up to the point where
marginal social benefit equals marginal social cost.
B. It refers to the inability of the market to allocate resources efficiently up to the point where
marginal social benefit equals marginal private cost.
C. It refers to a situation where an entire sector of the economy (for example, the airline
Industry. collapses because of some unforeseen event.
D. It refers to a breakdown in a market economy because of widespread corruption in
government.

3. Which of the following is a source of market failure?

A. unforeseen circumstances which leads to the bankruptcy of many firms
B. a lack of government intervention in a market
C. incomplete property rights or inability to enforce property rights
D. an inequitable income distribution

4. What are property rights?

A. the title to ownership of any physical asset
B. a legal document verifying ownership of intangible assets
C. the rights individuals or firms have to the exclusive use of their property, including the
right to buy or sell it
D. the right of the government to appropriate private assets for the good of society

5. Which of the following activities create a negative externality?

A. cleaning up the sidewalk on your block
B. graduating from college
C. repainting the house you live in to improve its appearance
D. keeping a junked car parked on your front lawn

6. A negative externality exists if

A. there are price controls in a market.
B. there are quantity controls in a market.
C. the marginal social cost of producing a good or service exceeds the private cost.
D. the marginal private cost of producing a good or service exceeds the social cost.
7. What is a "social cost" of production?
A. the cost of the resources used up in production
B. the total costs of producing a product, both implicit and explicit costs
C. the sum of all costs to individuals in society, regardless of whether the costs are borne by
those who produce the products or consume the product
D. the cost of the environmental damage created by production

8. Which of the following is an example of a positive externality?

A. banning the sale of candy in elementary schools
B. planting trees along a sidewalk which add beauty and creates shade
C. forbidding the use of cell phones in public
D. prohibit street parking in all residential neighborhoods

9. A positive externality causes

A. the marginal social benefit to be equal to the marginal private cost of the last unit
produced.
B. the marginal social benefit to be less than the marginal private cost of the last unit
produced.
C. the marginal social benefit of consuming a good or service to exceed the private benefit
D. the marginal private benefit of consuming a good or service to exceed the social benefit

10. When a negative externality exists, the private market produces

A. more than the economically efficient output level.
B. less than the economically efficient output level.
C. equal to the economically efficient output level
D. zero of the product

11. When a positive externality exists, the private market produces

A. more than the economically efficient output level.
B. less than the economically efficient output level.
C. equal to the economically efficient output level
D. zero of the product

12. Which of the following conditions holds in an economically efficient market

equilibrium?
A. The deadweight loss is positive but at a minimum.
B. Producer and consumer surplus are exactly equal in size.
C. There are no positive and no negative external effects from consumption and production.
D. The marginal benefit of the last unit produced and consumed is maximized.
Figure 1 shows a market with an externality. The current market equilibrium output of Q1
is not the economically efficient output. The economically efficient output is Q2.

13. Refer to Figure 1. Suppose the current market equilibrium output of Q1 is not the
economically efficient output because of an externality. The economically efficient output is Q2.
In that case, the diagram shows
A. the effect of a positive externality in the production of a good.
B. the effect of a negative externality in the production of a good.
C. the effect of an external cost imposed on a producer.
D. the effect of an external benefit such as a subsidy granted to consumers of a good.

14. Refer to Figure 1. If, because of an externality, the economically efficient output is Q2 and
not the current equilibrium output of Q1, what does S1 represent?
A. the market supply curve reflecting external cost
B. the market supply curve reflecting implicit cost
C. the market supply curve reflecting social cost
D. the market supply curve reflecting private cost
15. Refer to Figure 1. If, because of an externality, the economically efficient output is Q2 and
not the current equilibrium output of Q1, what does S2 represent?
A. the market supply curve reflecting private cost
B. the market supply curve reflecting social cost
C. the market supply curve reflecting external cost
D. the market supply curve reflecting implicit cost

16. A public solution that would push the supply curve from S1 to S2 would be
A. an application of the Coase Theorem
B. a Pigovian subsidy
C. to let the free market decide the outcome
D. a Pigovian tax

17. Economists argue that the level of pollution should be

A. reduced completely to zero because by definition, it is a negative external effect.
B. ignored because it has always been present since the beginning of history.
C. reduced to the point where the marginal benefit of pollution reduction is equal to the
marginal cost of pollution reduction to society.
D. best determined by elected officials who can speak on behalf of the public.

18. If producers do not bear the external cost of pollution in a production process,
A. the economically efficient level of production is achieved.
B. private production is below the economically efficient level.
C. private production exceeds the economically efficient level.
D. the market price is too high.

19. The Coase theorem states that

A. government intervention is always needed if externalities are present.
B. assigning property rights is the only thing the government should do in a market
economy.
C. if transactions costs are low, private bargaining will result in an efficient solution to the
problem of externalities.
D. a free market equilibrium is the best solution to address externalities.

20. Consider a situation in which a utility company emits high levels of sulfur dioxide and the
company is not liable for the damages its pollution causes. According to the Coase theorem,
government action is ________ to achieve an ________ amount of pollution.
A. necessary; equitable
B. necessary; efficient
C. not necessary; equitable
D. not necessary; efficient
21. Who was the economist who first proposed that governments use taxes and subsidies to
correct for externalities?
A. Ronald Coase
B. A. C. Pigou
C. Adam Smith
D. David Hume

22. What does the phrase "internalizing an external cost" mean?

A. limiting the extent to which domestic firms can outsource production
B. prohibiting economic activities that create externalities
C. forcing producers to factor into their production costs the cost of the externalities created
in the production of their output
D. finding a way to address cross-border pollution

23. If policymakers use a pollution tax to control pollution, the tax per unit of pollution should be
set
A. equal to the marginal external cost of pollution
B. equal to the marginal private cost of production
C. equal to the amount of the deadweight loss created in the absence of a pollution tax.
D. at a level low enough so that producers can pass along a portion of the additional cost onto
consumers without significantly reducing demand for the product.
Companies producing toilet paper bleach the paper to make it white. The bleach is
discharged into rivers and lakes and causes substantial environmental damage. Figure 2
illustrates the situation in the toilet paper market.

24. Refer to Figure 2. The efficient output is

A. Q1.
B. Q2.
C. Q3.
D. Q4.

25. Refer to Figure 2. The free market would produce what level of output?
A. Q1.
B. Q2.
C. Q3.
D. Q4.
26. Refer to Figure 2. An efficient way to get the firm to produce the socially optimal output
level is
A. for government to set a quota on the quantity of toilet paper that the toilet paper industry
can produce.
B. to impose a tax to make the industry bear the external costs it creates.
C. to grant a subsidy to enable the industry to internalize the external costs of production.
D. to assign property rights to the firms in the industry.

27. Refer to Figure 2. Suppose the government wants to use a Pigovian tax to bring about the
efficient level of production. What should the value of the tax be?
A. (P2-P1). per ton of output
B. (P2-P0). per ton of output
C. (P1-P0) per ton of output
D. P1 per ton of output

28. Refer to Figure 2. Let's suppose the government imposes a tax of $50 per ton of toilet paper
to bring about the efficient level of production. What happens to the market price of toilet paper?
A. It rises by $50.
B. It rises by more than $50.
C. It rises by less than $50.
D. It remains the same because the tax is imposed on producers who create the externality.

29. Government imposed quantitative limits on the amount of pollution firms are allowed to
produce is an example of
A. the Pigovian method of pollution control.
B. command and control approach to pollution reduction.
C. Coasian solution to pollution reduction.
D. a tradable emission allowance system of pollution control.

30. A product is considered to be rivalrous if

A. you can keep those who did not pay for the item from enjoying its benefits.
B. you cannot keep those who did not pay for the item from enjoying its benefits.
C. your consumption of the product reduces the quantity available for others to consume.
D. it is jointly owned by all members of a community.

31. A product is considered to be nonexcludable if

A. you can keep those who did not pay for the item from enjoying its benefits.
B. you cannot keep those who did not pay for the item from enjoying its benefits.
C. your consumption of the product reduces the quantity available for others to consume.
D. it is jointly owned by all members of a community.

32. Which of the following displays these two characteristics: rivalry and nonexcludability?
A. a public good.
B. a private good.
C. a quasi-public good.
D. a common-pool resource.
33. Which of the following displays these two characteristics: nonrivalry and nonexcludability in
consumption?
A. public goods
B. private goods
C. quasi-public goods
D. common-pool resources

34. Which of the following displays rivalry and excludability in consumption?

A. public goods
B. private goods
C. quasi-public goods
D. common-pool resources

35. Common-pool resources differ from public goods in that

A. common-pool resources are non-excludable while public goods are excludable to those who
do not pay for the good.
B. unlike public goods, common-pool resources are rivalrous in consumption.
C. common-pool resources are collectively owned by a group of people while public goods are
government owned.
D. common-pool resources are resources that cannot be renewed but the production of public
goods can be increased any time.

36. In economics, the term "free rider" refers to

A. a person who evades taxes.
B. a supervisor who delegates menial time-consuming activities to others.
C. one who volunteers her services.
D. one who waits for others to produce a good and then enjoys its benefits without paying for
it.

37. Private producers have no incentive to provide public goods because

A. the government subsidy granted is usually insufficient to enable private producers to
make a profit.
B. production of huge quantities of public goods entails huge fixed costs.
C. they cannot avoid the tragedy of the commons.
D. once produced, it will not be possible to exclude those who do not pay for the good.
38. Julie and Betty share an apartment and they are deciding whether or not to purchase a
weekly housecleaning service. The value of the service to each of them is $50 and it costs $80 to
hire a housecleaner. Suppose Betty is lazy and a spendthrift and Julie suspects that Betty will
be willing to pay $80. What is Julie likely to do, given that she is as rational as any other
person?
A. She will correctly rationalize that Betty's laziness and spendthrift ways are irrelevant to the
decision at hand.
B. She might claim that she is not willing to pay for a housecleaner, hoping that Betty would
pay the entire $80.
C. She might offer to do Betty's housecleaning chores if Betty would pay her $50.
D. She will come clean and tell Betty that since Betty is lazy and a spendthrift she should pay
a bigger share of the $80.

39. The "tragedy of the commons" refers to the phenomenon where

A. individuals are free riders.
B. people overuse a common-pool resource.
C. people do not internalize an externality.
D. there is rivalry in consumption.

40. A tragedy of the commons occurs when a resource is

A. rival and excludable.
B. . rival and non-excludable.
C. non-rival and non-excludable.
D. non-rival and excludable.

41. The basic cause of deadweight losses from the existence of common-pool resources and
externalities is
A. a lack of clearly defined and enforceable property rights.
B. the self interested rationality of human beings.
C. the use of a market system to deal with scarcity.
D. the absence of government intervention.
ANSWERS to Externalities, Public Goods and Common-Pool Resources Problem Set

1 C 21 B
2 A 22 C
3 C 23 A
4 C 24 B
5 D 25 C
6 C 26 B
7 D 27 B
8 B 28 C
9 C 29 B
10 A 30 C
11 B 31 B
12 C 32 D
13 B 33 A
14 D 34 B
15 B 35 B
16 D 36 D
17 C 37 D
18 C 38 B
19 C 39 B
20 D 40 A
41 A