MODULE 75

Avril Genao
Check Your Understanding
1. Some opponents of tradable emissions permits object to them on the
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grounds that polluters that sell their permits benefit monetarily from their
involvement in polluting the environment. Assess this argument.
This argument is wrong and misconcieved. Why? Well if a polluter
wants to sell the firm, it has to reduce emissions. So although they make
money from selling the permit, it can only be if they reduce contamination
and their amount of pollution

2. For each of the following cases, explain whether an external cost or an

external benefit is created and identify an appropriate policy response.
- Trees planted in urban areas improve air quality and lower summer
temperatures: This is an external benefit since not only those who plant
the trees benefit from it since the whole area will have improved air quality
and lower summer temperatures. An appropriate policy response would be
to create a pigouvian subsidy on each tree in order to increase MPB until it
is equal to MSC.

- Water-saving toilets reduce the need to pump water from rivers and
aquifers. The cost of a gallon of water to homeowners is virtually zero: The
marginal social benefit is larger than the marginal social cost since its
almost zero for homeowners to replace the toilet yet the environmental
response is much better. An appropriate policy response would be to
create a pigouvian subsidy for the installment of these new toilets to bring
marginal private benefit to these homeowners

- Old computer monitors contain toxic materials that pollute the

environment when improperly disposed of: This causes an external cost
since the benefit of throwing away the old computer with toxic materials is
lower than the cost it has on the environment. An appropriate policy
response would be to create a pigouvian tax for the old computer monitor
to raise the MPC to equal the MSC

Multiple Choice Questions

. Which of the following policy tools is inefficient even when correctly
administered?
○ environmental standards: most environmental standards currently

“are inflexible and don’t allow reductions in pollution to be

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achieved at the lowest possible cost”. There are more efficient

ways to deal with pollution according to the book
○ emissions taxes
○ tradable emissions permits
○ Pigouvian taxes
○ cap and trade programs

. An efficient Pigouvian subsidy for a good is set equal to the good’s

○ external cost.
○ marginal social benefit.
○ marginal external cost.
○ marginal external benefit: ”A Pigouvian subsidy is a payment

designed to encourage purchases and activities that yield external

benefits”, therefore it is set to equal the marginal external benefit
○ price at which MSC = MSB.

. Which of the following is true in the case of a positive externality?

○ MSC > MSB
○ MPB>MSC
○ MSB > MPB: its pretty self explainatory the marginal social

benefits must be bigger than the marginal private benefit

○ MPB>MSB
○ MSC>MPC

4. One example of a source of external benefits is

○ technology spillover: external benefits are the ones that an

individual confers on others w/o recieving compensation and its

what will happen with technology spillovers since these are
UNINTENTIONAL technological benefits to firms that come from
research of other firms without the costs
○ traffic congestion.
○ pollution.
○ subsidies for polluters.
○ taxes on environmental conservation.

5. Marginal social benefit equals marginal private benefit plus

○ marginal external benefit: “MSC = MPC + MEC ”
○ marginal private cost.
○ total external benefit.
○ total external cost.
○ marginal social cost.

Free Response Questions

1. The purchase of antivirus software by one person provides benefits to
other people because they are less likely to receive a virus from the
software purchaser. Draw a correctly labeled graph showing how the
market will determine the quantity of antivirus software purchased. On the
same graph, show the socially optimal quantity of antivirus software. List
two different government policies that could be used to achieve the
optimal quantity of antivirus software.

2. The use of plastic water bottles creates external costs as the result of
plastic production, bottle transportation, litter, and waste disposal. Draw a
correctly labeled graph showing how the market will determine the
quantity of water bottles purchased. On the same graph, show the
marginal external cost, the socially optimal quantity of water bottles, and
the size of a Pigouvian tax that could be used to achieve the socially
optimal quantity of water bottles.