Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

CHAPTER 5 - Externalities

Multiple-Choice Questions

1. Reducing output from the privately optimal level to the socially optimal level will
a) cause a loss of consumption to consumers.
b) reduce marginal damages.
c) reduce the production costs.
d) cause all of the above.

2. Marginal damages are hard to measure because

a) they can be generated from multiple sources.
b) they are hard to graph.
c) they happen over time.
d) no one cares about them.

3. In Figure 5.4, if the marginal damages line did not originate at 0,

a) it would mean that marginal damages did not exist.
b) there is no way to find MSC.
c) MSC would not originate at the same intercept as MPC.
d) then all of the above.

4. Externalities can be positive because

a) marginal damages do not last over time.
b) utility can be impacted positively as well as negatively.
c) there is no concept for marginal benefit.
d) positive externalities are subsidies.

5. Refer to the graphs below. Which graph(s) represent(s) an externality?

a) graph A
b) graphs A and B
c) graph B
d) neither graph A nor graph B

A B
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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

6. Refer to Figure 5.7 in the textbook. What does it mean if all firms have to reduce to a
( Z *  X *)
point ?
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a) Firm X will reduce more than optimal.
b) Firm Z will reduce less than optimal.
c) The new point is between X* and Z*.
d) All of the above.

7. The Coase theorem has problems because

a) generally, bargaining costs are not zero.
b) individuals are not concerned with others.
c) markets always exist.
d) all of the above.

8. Pollution rights may be traded if

a) polluters try to hide pollution.
b) administrators are uncertain about Pigouvian taxes.
c) there is no market for pollution.
d) pollution is harmless.

9. Externalities can be produced by ____________, as well as ____________.

a) individuals; firms
b) market prices; market incomes
c) oceans; streams
d) none of the above

10. A Pigouvian tax corrects for

a) market congestion.
b) market losses.
c) inefficient sales.
d) low market prices.

11. Which of the following is correct?

a) SMC = PMC - MD
b) MPB = MSB + MEB
c) SMC = PMC + MD
d) MSC = MPB
e) MSB =MSC + MPB

12. Marginal benefits are downward sloping when

a) there are no total benefits.
b) the slope of the marginal benefits curve is negative.
c) total benefits are increasing at a decreasing rate.
d) marginal costs are upward sloping.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

13. A Pigouvian subsidy

a) can not exist with externalities.
b) is the same thing as a Pigouvian tax.
c) is measured in terms of Pigouvian dollars.
d) moves production to the socially optimal level of output.

14. As a general rule, zero pollution is not socially desirable because

a) there would be no production.
b) the Environmental Protection Agency (EPA) needs to have something to do.
c) no pollution would lead to global warming.
d) all of the above.

15. Externalities require government intervention when

a) violence will result between disputing parties.
b) there are only a few sellers in the market.
c) property rights are not clearly established.
d) the government imposes sales taxes.
e) all of the above.

16. Which method helps in obtaining the socially optimal level of output?
a) Pigouvian taxes
b) regulation
c) property rights and bargaining
d) all of the above

17. Marginal damages

a) must always be considered in social marginal costs.
b) must not be considered in social marginal costs.
c) must sometimes be considered in social marginal costs.
d) have nothing to do with social marginal costs.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

Discussion Questions

1. Suppose the factory Afro-Puffs Inc. produces wigs. As a by-product of this wig
production, they also produce dangerous emissions of toxic gases (as a result of the
strong glue used to hold the hair in place). The De-Lite car factory, down the road,
experiences a negative externality from this production process. Suppose that the supply
curve (private marginal costs) for the wig factory is X=(2/5)P- 2, and it faces a market
demand of Xd=15 - P/2. The marginal damages caused by the production of wigs can be
written as X=P – 1/2.
a. Find the equilibrium price and quantity in the market for wigs.
b. Find the socially optimal level of wigs and the corresponding price.
c. How much should the wig factory be taxed per wig?

2. A steel factory has the right to discharge waste into a river. The waste reduces the
number of fish, causing damage for swimmers. Let X denote the quantity of waste
dumped. The marginal damage, denoted MD, is given by the equation MD = 2 + 5X.
The marginal benefit (MB) of dumping waste is given by the equation MB = 34 – 3X.
a. Calculate the efficient quantity of waste.
b. What is the efficient fee, in dollars per unit of waste, that would cause the firm to
dump only an efficient quantity of waste?
c. What would be the quantity dumped if the firm did not care about the fishery?

3. The private marginal benefit for commodity X is given by 15 – X, where X is the number
of units consumed. The private marginal cost of producing X is constant at 10. In the
absence of any government intervention, how much X is produced? What is the gain to
society involved in moving from the inefficient to the efficient level of production?

4. Consider the case of two farmers, Tony and Hakim, depicted in the figure below. Both
use DDT (a chemical pesticide) for their crops. The use of DDT causes an externality for
swimmers down river from the farms.
a. Show the amount of pesticides used if each uses the privately optimal level of
pesticides.
b. Show the amount of pesticides used if they are socially concerned.
c. Why is a reduction back to XH = HT not socially desired?

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

MB/MC

SMC(PMC+MB)

PMC

MBH

MBT
X H X T Pesticides

5. Redo discussion question 10, part a, from Chapter 5 in your book. Suppose emissions are
limited to 25 units per year instead of 50. How does your answer change?

True/False/Uncertain Questions

1. Externalities always work themselves out.

2. Negative externalities cause loss of welfare not transmitted by market factors.

3. Externalities can be positive, as well as negative.

4. A subsidy for pollution not produced can induce producers to pollute at the efficient level.

5. Pollution rights can be traded and are always efficient.

6. Regulation helps to correct for externalities.

7. Any commodity market has the potential to have an externality.

8. Market-oriented solutions to externalities rarely work.

9. For market efficiency, MSC must be equated to MSB.

10. College education is an example of a positive externality.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

Essay Questions

1. How do social conventions help in alleviating externalities without government

intervention?

2. How do you feel the U.S. has fared in its attempt to impose market forces to correct
externalities?

3. List and discuss three problems that might arise when using the Coase theorem.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

Chapter 5

Externalities

Multiple-Choice

1. Reducing output from the privately optimal level to the socially optimal level will

A) cause a loss of consumption to consumers.

B) reduce marginal damages.C) reduce the production costs.D) cause all of the above.

Ans: d

2. Marginal damages are hard to measure because

A) they can be generated from multiple sources.B) they are hard to graph.C) they happen
over time.

D) no one cares about them.

Ans: a

3. In Figure 5.4, if the marginal damages line did not originate at 0,

A) it would mean that marginal damages did not exist.B) there is no way to find MSC.

C) MSC would not originate at the same intercept as MPC.D) then all of the above.

Ans: c

4. Externalities can be positive because

A) marginal damages do not last over time. B) utility can be impacted positively as well as
negatively.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

C) there is no concept for marginal benefit. D) positive externalities are subsidies.

Ans: b

5. Refer to the graphs below. Which graph(s) represent(s) an externality?

A) graph AB) graphs A and BC) graph BD) neither graph A nor graph B

Ans: c 6. Refer to Figure 5.7 in the textbook. What does it mean if all firms have to reduce
to a point (Z*?X*)

2?

A) Firm X will reduce more than optimal.

B) Firm Z will reduce less than optimal.

C) The new point is between X* and Z*.D) All of the above.Ans: d

7. The Coase theorem has problems because

A) generally, bargaining costs are not zero.B) individuals are not concerned with others.C)
markets always exist.D) all of the above.

Ans: a

8. Pollution rights may be traded if

A) polluters try to hide pollution.B) administrators are uncertain about Pigouvian taxes.

C) there is no market for pollution.D) pollution is harmless.

Ans: b

9. Externalities can be produced by ____________, as well as ____________.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

A) individuals; firmsB) market prices; market incomes

C) oceans; streamsD) none of the aboveAns: a

10. A Pigouvian tax corrects for

A) market congestion.B) market losses.C) inefficient sales.D) low market prices.

Ans: d

11. Which of the following is correct?

A) SMC = PMC - MD B) MPB = MSB + MEB

C) SMC = PMC + MD D) MSC = MPB E) MSB =MSC + MPB

Ans: c

12. Marginal benefits are downward sloping when

A) there are no total benefits.B) the slope of the marginal benefits curve is negative.

C) total benefits are increasing at a decreasing rate.D) marginal costs are upward sloping.

Ans: b

13. A Pigouvian subsidy

A) can not exist with externalities. B) is the same thing as a Pigouvian tax.

C) is measured in terms of Pigouvian dollars.

D) moves production to the socially optimal level of output.

Ans: d

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

14. As a general rule, zero pollution is not socially desirable because

A) there would be no production.

B) the Environmental Protection Agency (EPA) needs to have something to do.

C) no pollution would lead to global warming. D) all of the above.

Ans: a

15. Externalities require government intervention when

A) violence will result between disputing parties.

B) there are only a few sellers in the market.

C) property rights are not clearly established.

D) the government imposes sales taxes.

E) all of the above.

Ans: c

16. Which method helps in obtaining the socially optimal level of output?

A) Pigouvian taxesB) regulation

C) property rights and bargainingD) all of the aboveAns: d

17. Marginal damages

A) must always be considered in social marginal costs.B) must not be considered in social
marginal costs.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

C) must sometimes be considered in social marginal costs.D) have nothing to do with social
marginal costs.

Ans: a

18. A tax levied on each unit of pollution is

A) a income taxB) a emissions feeC) a flat taxD) an international taxAns: b

19. A cap-and-trade policy

A) has a set number of permits

B) allows polluters to trade permitsC) caps the total level of pollution allowedD) all of the
above E) none of the above

Ans: d

20. Command-and-control regulations

A) are less flexible than incentive based regulationsB) come from the private sector

C) have technology standards a type of controlD) a & cE) a & b

Ans: d

Essay

21. Suppose the factory Afro-Puffs Inc. produces wigs. As a by-product of this wig
production, they also produce dangerous emissions of toxic gases (as a result of the strong glue
used to hold the hair in place). The De-Lite car factory, down the road, experiences a negative
externality from this production process. Suppose that the supply curve (private marginal costs)
for the wig factory is X=(2/5)P- 2, and it faces a market demand of Xd=15 - P/2. The marginal
damages caused by the production of wigs can be written as X=P – 1/2.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

(a.) Find the equilibrium price and quantity in the market for wigs.

(b.) Find the socially optimal level of wigs and the corresponding price.

(c.) How much should the wig factory be taxed per wig?

Ans:

(a.) Set PMC equal to demand and solve for P and X. X= 50/9, P = 170/9.

(b.) Find SMC by adding PMC to MD. Set SMC equal to demand and solve for P and X. X
= 49/11, P = 232/11.

(c.) At X = 49/11, subtract PMC from SMC. Tax = 109/22.

22. A steel factory has the right to discharge waste into a river. The waste reduces the
number of fish, causing damage for swimmers. Let X denote the quantity of waste dumped. The
marginal damage, denoted MD, is given by the equation MD = 2 + 5X. The marginal benefit
(MB) of dumping waste is given by the equation MB = 34 – 3X.

(a.) Calculate the efficient quantity of waste.

(b.) What is the efficient fee, in dollars per unit of waste, that would cause the firm to dump
only an efficient quantity of waste?

(c.) What would be the quantity dumped if the firm did not care about the fishery?

Ans:

(a.) Set MD = MB and solve for X. X= 32/6.

(b.) Insert 32/6 into either MD or MB. Fee = 86/3.

(c.) Set MB equal to zero and solve for X. X = 34/3.

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

23. The private marginal benefit for commodity X is given by 15 – X, where X is the
number of units consumed. The private marginal cost of producing X is constant at 10. In the
absence of any government intervention, how much X is produced? What is the gain to society
involved in moving from the inefficient to the efficient level of production?

Ans: Without intervention, optimal will be where PMB = 0. X = 15. The efficient level is X
= 5. The area beneath the PMB is gained. Gain = 25.

24. Consider the case of two farmers, Tony and Hakim, depicted in the figure below. Both
use DDT (a chemical pesticide) for their crops. The use of DDT causes an externality for
swimmers down river from the farms.

(A) Show the amount of pesticides used if each uses the privately optimal level of
pesticides.

(B) Show the amount of pesticides used if they are socially concerned.

(C) Why is a reduction back to XH = HT not socially desired?

Ans: (A)

(B)

C) Not socially optimal.

25. Redo discussion question 10, part a, from Chapter 5 in your book. Suppose emissions
are limited to 25 units per year instead of 50. How does your answer change?

Ans: Put 25 into demand equation. P = 7.5.

26. Externalities always work themselves out.

A) True.B) False.C) Uncertain.Ans: b

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Test Bank to accompany Rosen’s Public Finance, Seventh Edition Chapter 5

27. Negative externalities cause loss of welfare not transmitted by market factors.

A) True.B) False.C) Uncertain.Ans: a

28. Externalities can be positive, as well as negative.

A) True.B) False.C) Uncertain.Ans: a

29. A subsidy for pollution not produced can induce producers to pollute at the efficient
level.

A) True.B) False.C) Uncertain.Ans: a

30. Pollution rights can be traded and are always efficient.

A) True.B) False.C) Uncertain.Ans: c

31. Regulation helps to correct for externalities.

A) True.B) False.C) Uncertain.Ans: a

32. Any commodity market has the potential to have an externality.

A) True.B) False.C) Uncertain.Ans: c

33. Market_oriented solutions to externalities rarely work.

A) True.B) False.C) Uncertain.Ans: b

34. For market efficiency, MSC must be equated to MSB.

A) True.B) False.C) Uncertain.Ans: a

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