Microeconomics Australia 7th Edition Mctaggart Solutions Manual

Microeconomics Australia 7th Edition
McTaggart Solutions Manual

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C h a p t e r 9 ECONOMICS OF
THE ENVIRONMENT
Answers to the Review Quizzes

Page 201
1. What is the distinction between private cost and social cost?
A private cost of production is the cost of producing a good or service that is borne only by the
producer. A social cost of production includes the private costs of production as well as the external
costs of production borne by people other than the producer.
2. How does a negative externality prevent a market from using resources efficiently?
External costs create a marginal social cost (MSC) that exceeds the marginal private cost (MC) for
producing or consuming a good or service. That is, with an external cost, MSC > MC. When the firm
produces a good or service with an external cost, it chooses to produce the quantity at which marginal
cost equals marginal benefit, MC = MB. Marginal benefit equals marginal social benefit, MSB. In this
case, the firm produces the quantity at which MC = MSB. This level of production exceeds the level at
which MSC = MSB. Too much of the good or service is produced, resulting in an inefficient allocation
of resources.
3. How do property rights eliminate externalities?
The existence of a negative externality means some group must bear some of the costs of a production
or consumption activity for which they are not involved. The Coase theorem implies that assigning a
property right to either the group generating the externality or the group bearing the externality costs
will eliminate the inefficient allocation of resources. The Coase theorem applies if the number of
parties involved is small and if transactions costs are low.
4. How do Pigovian taxes work?
A Pigovian tax on the producers of the activities that generate pollution or other negative externality
will force these producers, when deciding about their level of production, to take account of the
external costs they impose on society. If the amount of the tax imposed equals the marginal external
cost of the activity, then the producers will choose to produce at the efficient level.
5. How do emission charges and marketable pollution permits work?
Emission charges force each polluting firm to pay a cost for a unit of pollution. For marketable
permits, the regulating agency first determines the total amount of pollution to be allowed. Each firm
that might potentially pollute is then assigned a permitted amount of pollution to be emitted per period
and is allocated sufficient permits to allow this amount of pollution. For any firm to exceed this
amount, it must buy pollution permits held by another firm. Each firm faces an opportunity cost for
selling its emissions permits, namely the cost of cleaning up its pollution. The price of buying an extra
emissions permit will reflect the opportunity cost of the firm that sells the permits. Those firms with
lower costs of cleaning pollution will sell their permits to those firms with higher costs. The total
amount of pollution will equal the total amount allowed.
© 2013 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442550773/McTaggart/Economics/7e
ECONOMICS OF THE ENVIRONMENT 2
Page 405
1. What is the tragedy of the commons? Give two examples, including one from your state.
The tragedy of the commons is the absence of incentives to prevent the overuse and depletion of a
commonly owned resource. The private market place will not use the quantity of a common resource
efficiently. Some examples include the public car parks near a football stadium whenever a major
game is played, or the free Internet access computer at the local library.
2. Describe the conditions under which a common resource is used efficiently.
A common resource is used efficiently when the marginal social benefit equals the marginal social cost
at the quantity produced.
3. Review three methods that might achieve the efficient use of a common resource and explain the
obstacles to efficiency.
There are three different methods that government can use to obtain the efficient allocation of
resources in the event of a common resource:
• Property rights are assigned to private property, which is a resource that someone owns and
has an incentive to use in a way that maximises its value. However, assigning property rights
to resources is not always feasible, such as with the fish that migrate over the vast depths of
the oceans.
• Production quotas can be set for total catch and divided among harvesting consumers so that
the marginal benefit from harvesting equals the marginal cost of harvesting. However, it is in
every harvester’s best interest to cheat on the quota, because marginal private benefit from
exceeding the quota allotment is greater than the marginal cost of harvesting.
• Individual transferable quotas (ITQ) is a production limit that is assigned to an individual
harvester who is free to transfer the quota to someone else.
Answers to the Study Plan Problems and Applications

Figure 9.1 illustrates the market for tomatoes. A small town is surrounded by a large tomato farm. The
tomato grower sprays the plants with chemicals to control disease and the chemical waste flows into the
river passing through the town. The marginal external cost of the chemical waste is equal to the
marginal private cost of producing tomatoes.
1. If no one owns the river and the town takes no action to control the waste, what is the quantity of
tomatoes, and the deadweight loss created?
400 tonnes of tomatoes are produced. In Figure 9.2, the deadweight loss that is created is equal to the
area of the grey triangle. So the deadweight loss is equal to ½ × ($100 per tonne − $50.00 per tonne) ×
100 tonnes, which is $2,500.
2. a. If the town owns the river and makes the tomato grower pay the cost of pollution, how many
tomatoes are produced? What does the grower pay the town per tonne of tomatoes produced?
If the town owns the river and transactions costs are low, so that the Coase theorem applies, the
efficient quantity of tomatoes is produced, 300 tonnes. The farmer pays the town an amount equal to
the marginal external cost at the efficient quantity, which is $37.50 per tonne of tomatoes.
b. If the tomato grower owns the river and rents it to the town, how many tomatoes are produced?
How is the rent paid by the town to the grower (per tonne of tomatoes produced) influenced by
tomato growing?
Using the Coase theorem, if the tomato grower owns the river, the efficient quantity of tomatoes is
produced, 300 tonnes. The city must pay the grower to compensate the grower for limiting the use of
chemicals. The city will pay $37.50 per tonne of tomatoes, the external cost at the efficient quantity.
The total amount paid per month is $37.50 per tonne multiplied by 300 tonnes, which is $11,250.
c. Compare the quantities of tomatoes produced in parts (a) and (b) and explain the relationship
between these quantities.
The quantities produced are the same and are equal to the efficient quantity. This result reflects the
Coase theorem, that when transactions costs are low, then assigning property rights results in the
efficient outcome regardless of to whom the property rights are given.
3. If no one owns the river and the town introduces a pollution tax, what is the tax per tonne of
tomatoes produced that achieves an efficient outcome?
The tax is equal to the marginal external cost at the efficient quantity, which is $37.50 per tonne of
pesticide.
4. Compare the outcome when property rights exist and when the pollution tax achieves the
efficient amount of waste.
The quantity of tomatoes produced is the same in both cases and is the efficient amount. Once again
this result reflects the Coase theorem, which states that when transactions costs are low, then assigning
property rights results in the efficient outcome.
5. Suppose that no one owns the river and that the government issues two marketable pollution
permits: one to the tomato grower and one to the city. Each permit allows the same amount of
pollution of the river, and the total pollution created is the efficient amount. What is the quantity
of tomatoes produced and what is the market price of a pollution permit? Who buys and who
sells a permit?
The quantity of tomatoes grown will be the efficient quantity, 300 tonnes. The grower will buy the
permit from the city. Each permit allows 150 tonnes of tomatoes to be produced. The market price of a
permit will be $5,625, which equals $37.50 per tonne × 150 tonnes. The tomato grower can sell 300
tonnes of tomatoes for $75 per tonne. The marginal cost of the 300th tonne is $37.50 per tonne. The
grower can already produce 150 tonnes of tomatoes so the grower is willing to buy the permit to
produce 150 more tonnes as long as the price per tonne is not greater than $37.50 per tonne, that is,
the (total) price is not greater than $5,625. The city bears a cost of $37.50 per tonne for the 300th tonne
and less than that for the tonnes from 151 to 299 tonnes. So the town is willing to sell the permit for no
less than $37.50 per tonne, that is, the (total) price is not less than $5,625. The most the grower is
willing to pay is $5,625 and the least the town will accept is $5,625, so that is the price of the permit.
Use the following news clip to work Problems 6 to 7.
Price of Flights to Take Off
Europe’s highest court has ruled that the European Union has the legal right to force foreign airlines to
pay for their greenhouse gas emissions, a decision that could force rises in ticket prices but also
encourage airlines to curb carbon outputs.
Source: Sydney Morning Herald, 23 December 2011
6. What are the externalities created by the airline industry? Would airlines reduce emissions
without any government regulation? Would that outcome be efficient?
Greenhouse gas emissions and aircraft noise are two negative externalities created by the airline
industry. The profit-maximising, market equilibrium output of the airlines would be greater than the
efficient output if there was no government regulation.
7. How would taxes encourage airlines to operate in the social interest?
If the government intervenes in the market taxing the airlines’ output it forces them to confront the full
costs of their polluting production and the airlines will have a self-interest in polluting less. Their
profit-maximising output is lower than when they ignore the cost of pollution and with government
intervention self-interest achieves the social interest.
Use the following news clip to work Problems 8 and 9.

Plastic Shopping Bags and the Environment
Following the apparent success of the plastic bag tax in Ireland in reducing the number of plastic
shopping bags used there, some state and territory governments in Australia have banned or are
planning to ban plastic shopping bags.
Source: ABC Science, 2010
8. a. Describe the externality that arises from plastic containers and bags.
When discarded, plastic bags create costs that are not paid by their users. Bags in trees create visual
pollution and potentially can harm birds. Bags in oceans also create visual pollution and can
definitely harm sea life. These are all external costs because the bags’ users do not bear these costs.
b. Draw a graph to illustrate how plastic containers and bags
create deadweight loss.
Figure 9.3 illustrates the market for plastic bags. In the
absence of any government regulation or policy, the
competitive equilibrium is 500 million plastic bags per year.
But the external costs from plastic bags means that the
marginal social cost of a plastic bag exceeds the marginal
(private) cost so the MSC curve lies above the S = MC curve.
The allocatively efficient number of plastic bags is 200
million plastic bags per year. Plastic bags are overproduced.
The deadweight loss from this overproduction is equal to the
area of the grey triangle in the figure.
9. a. Explain why a tax might be more efficient than a ban on
plastic containers and bags.
A complete ban on bags means that the quantity of bags is zero. But at this quantity the marginal social
benefit of a bag exceeds its marginal social cost. Banning bags would create a deadweight loss because
the bags for which the marginal social benefit exceeds the marginal social cost are not being produced
and used.
b. Explain the effects on the use of plastic containers if there was a law making manufacturers pay
for recycling.
A law making manufacturers pay for recycling plastic containers would increase the cost of
manufacture and reduce the supply, a shift of the supply curve for plastic containers to the left. The
reduction in supply would increase the price and reduce the number of plastic containers used.
Use the following news clip to work Problems 10 to 12.
Mobile Phones as Dangerous as Drunk Driving
Researchers found that drivers using mobile phones drove more slowly, braked more slowly and were
more likely to crash than other drivers and even more likely to crash than drunken drivers.
Source: CNET, 1 July 2006
10. a. Explain the external costs that arise from using a mobile phone while driving.
The driver creates an external cost because other drivers, bike riders and pedestrians are at greater
risk of being injured in an accident by a mobile phone using driver.
b. Explain why the market for mobile phone service creates a deadweight loss.
The market for mobile phones creates a deadweight loss because mobile phone users do not pay a
higher price to use a mobile phone when they are driving so they do not pay the total marginal social
cost of using a mobile phone while driving. Because the equilibrium quantity is determined without
considering the external cost, mobile phones are overused while driving.
11. Draw a graph to illustrate how a deadweight loss arises from the use of mobile phones.
Figure 9.4 shows the market for making mobile phone
calls. The marginal private cost of using a mobile phone
is less than the marginal social cost because of the
marginal external cost, the increased likelihood of
someone else being injured. As a result the marginal
social cost curve, labelled MSC, lies above the marginal
private cost and supply curve, labelled S = MC. The
demand curve is the same as the marginal social benefit
curve and is labelled D = MSB in the figure. The
equilibrium number of mobile phone minutes is 500
minutes per month and the efficient quantity is 200
minutes per month. Mobile phones are overused in cars.
The resulting deadweight loss is equal to the area of the
grey triangle in the figure.
12. Explain how government intervention might improve
the efficiency of mobile phone use.
The government could impose a tax on mobile phone use in a car equal to the marginal external cost
(5¢ a call in Figure 9.4). In this case the marginal private cost would become the same as the marginal
social cost and the efficient outcome would result. Such a tax, however, would be difficult to enforce
because it would apply only when the call was made while the caller was driving a car. Alternatively
the government could assign property rights. For instance the government could declare that any driver
who causes an accident while using a mobile phone is responsible for the injuries and damage created
by the accident. In this case the external cost of talking on a mobile phone will be internalised by the
mobile phone user.
13. Plan to Cut Toxic Run-off a Win for Reef
Parts of the Great Barrier Reef have lost up to 50 per cent of their coral because of water
pollution from farm chemicals and soil erosion flowing into the ocean. The Queensland
government is funding research into exactly how much fertiliser is needed by farmers to maintain
productivity and cut toxic run-off.
Source: Bigpond News, 18 November 2011
Why is the Great Barrier Reef under threat from pollution? Why is the government funding the
research to protect the reef? Would a ban on the use of chemicals and fertilisers be more
efficient?
The threat to the Great Barrier Reef from herbicide and pesticide chemicals run-off is a negative
externality. The level of farm production and use of chemicals depends on marginal private costs and the
market equilibrium. The marginal private cost is less than the marginal social cost and the quantity
produced is greater than the efficient level. The market has overprovided a good with a negative
externality, so public choices must find ways of restricting their provision.
The Great Barrier Reef is considered one of the seven wonders of the natural world and has world
heritage listing. The benefits from protecting the reef are both nonexcludable and nonrival and therefore
a public good. The market would underprovide the level of research and public choices are needed to
increase their provision.
The ban on the use of chemicals and fertilisers will only be efficient if the marginal social cost of their
use is greater than the marginal benefit even at close to zero use. This will depend on the value placed on
the damage to the reef. Funding research may find a solution where farmers use less fertiliser and other
chemicals without a drop in productivity so that the marginal social cost of production is equal to the
marginal social benefit at the quantity determined by the market.
Use the following figure to work Problems 14 to 16.
The figure shows the market for North Atlantic tuna.
14. a. What is the quantity of tuna that fishers catch
and the price of tuna? Is the tuna stock being
used efficiently? Explain why or why not.
When the market is unregulated, the quantity of
fish caught and their price is determined by the
equilibrium between supply and demand. The
demand curve is the same as the MSB curve so
Figure 9.5 shows that the equilibrium quantity of
tuna is 80 tonnes and the equilibrium price is $100
per tonne. The tuna stock is not being used
efficiently. The efficient quantity of tuna is
determined by the intersection of the MSC curve
and the MSB curve. Figure 9.5 shows that the
efficient quantity of tuna is 40 tonnes. Tuna, a
common resource, is overfished.
b. What would be the price of tuna, if the stock of tuna is used efficiently?
If tuna was used efficiently, 40 tonnes per month would be caught and the price would be $150 per
tonne.
15. a. With a quota of 40 tonnes a month for the tuna fishing industry, what is the equilibrium price of
tuna and what quantity for tuna that fishers catch?
With a quota of 40 tonnes per month, the quantity of tuna caught will be 40 tonnes and the price will
be $150 per tonne.
b. Is the equilibrium an overfishing equilibrium?
As long as the quota is enforced so that fishers cannot cheat on their allocation, the equilibrium with
the 40-tonne quota is efficient. Tuna is not overfished.
16. If the government issues ITQs to individual fishers that limit the total catch to the efficient
quantity, what is the market price of an ITQ?
The price of an ITQ equals the marginal social benefit at the quantity caught minus the marginal cost
at the quantity caught. In Figure 9.5, the price of an ITQ is $150 per tonne minus $50 per tonne, or
$100.
17. Whaling “Hurts Tourist Industry”
Leah Garces, the director of programs at the World Society for the Protection of Animals,
reported that whale watching is more economically significant and sustainable to people and
communities than whaling. The global whale-watching industry is estimated to be a $1.25 billion
business enjoyed by over 10 million people in more than 90 countries each year.
Source: BBC, 2 June 2009
Describe the tradeoff facing communities that live near whaling areas. How might a thriving
whale-watching industry avoid the tragedy of the commons?
The tradeoff in these communities is stark: If whales are caught and processed, the whale-watching
market will disappear (along with the whales). If whale watching takes off, it will become more
profitable for boat owners to use their boats (or buy new ones) to take tourists to watch the whales
rather than to use their boats to hunt the whales. Whale watching is not a common resource because
whale watching is nonrival. Indeed, it increases the incentives to conserve whales. Whale watching is
not a common resource so the tragedy of the commons is avoided because whales are not “overused”.
Use the following information to work Problems 18 to 20.
A natural spring runs under land
Quantity of Marginal external Marginal social
owned by ten people. Each person
water cost benefit
has the right to sink a well and can
(litres per day) (dollars per litre) (dollars per litre)
take water from the spring at a
10 1 10
constant marginal cost of $5 a litre.
20 2 9
The table sets out the external cost
30 3 8
and the social benefit of water.
40 4 7
18. Draw a graph to illustrate the 50 5 6
market equilibrium. On your 60 6 5
graph, show the efficient 70 7 4
quantity of water taken.
Figure 9.6 illustrates the situation. In the figure, the
market equilibrium will be at the quantity of water
that sets the marginal private cost, the curve labelled
MC in the figure, equal to the marginal private beneift,
which is the same as the marginal social benefit and is
illustrated in the figure by the curve labelled MB =
MSB. This quantity is 60 litres per day. The efficient
quantity of water is the quantity of water that sets the
marginal social cost, the curve labelled MSC in the
figure, equal to the marginal social benefit. This
quantity is 30 litres of water per day.
19. If the government set a quota on the total amount of water such that the spring is used efficiently,
what would that quota be?
If the government set a quota so that the efficient amount of water is taken, the quota on water taken
would equal 30 litres per day because that is the efficient quantity.
20. If the government issues ITQs to land owners that limit the total amount of water taken to the
efficient quantity, what is the market price of an ITQ?
The market price of an ITQ equals the marginal social benefit minus the marginal private cost at the
efficient quantity. As Figure 9.6 illustrates, at the efficient quantity of 30 litres, the marginal social
benefit is $8 per litre and the marginal private cost is $5 per litre, so the market price of an ITQ is $3
per litre.
Answers to the Additional Problems and Applications

21. Betty and Anna work at the same office in Canberra. They both must attend a meeting in Sydney,
so they decide to drive to the meeting together. Betty is a cigarette smoker and her marginal
benefit from smoking a package of cigarettes a day is $40. Cigarettes are $6 a pack. Anna
dislikes cigarette smoke, and her marginal benefit from a smoke-free environment is $50 a day.
What is the outcome if
a. Betty drives her car with Anna as a passenger?
If Betty drives her car, Betty has the property right to the air in her car. Anna can offer to pay Betty
some amount more than $34 and less than $50 to not smoke. Betty will accept and will not smoke on
the trip. Betty’s net benefit from smoking is $34 (the net benefit equals the marginal benefit, $40,
minus the price of the pack, $6) so for any amount greater than $34 she is willing to not smoke. Anna
values a smoke-free environment at $50, so Anna is willing to pay any amount less than $50 for a
smoke-free environment.
b. Anna drives her car with Betty as a passenger?
If Anna drives her car, Anna has the property right to the air in her car. Betty will not smoke because
she will not offer Anna a high enough price to allow Betty to smoke.
Use the following information and the figure, which
illustrates the market for a pesticide with no government
action, to work Problems 22 to 25.
When factories produce pesticide, they also create
waste, which they dump into a lake on the outskirts of
the town. The marginal external cost of the waste is
equal to the marginal private cost of producing the
pesticide (that is, the marginal social cost of producing
the pesticide is double the marginal private cost).
22. What is the quantity of pesticide produced if no
one owns the lake and what is the efficient
quantity of pesticide?
If no one owns the lake the equilibrium quantity
of pesticide produced is determined at the
intersection of the demand curve and supply
curve, 30 tonnes per week. The efficient quantity is determined at the intersection of the marginal
social benefit curve and the marginal social cost curve. The marginal social benefit curve is the same
as the demand curve. But the marginal social cost curve differs from the supply curve because of the
external cost. The efficient quantity of pesticide is 20 tonnes per week because at this quantity the
marginal social benefit, $100 per tonne, equals the marginal social cost, also $100 per tonne.
23. If the residents of the town own the lake, what is the quantity of pesticide produced and how
much do residents of the town charge the factories to dump waste?
Assuming that the transactions costs are low so that the Coase theorem applies, if the residents of the
town own the lake, the efficient quantity of pesticide is produced, 20 tonnes per week. The residents
charge the pesticide companies $50 per tonne to dump their waste in the lake.
24. If the pesticide factories own the lake, how much pesticide is produced?
Assuming that the transactions costs are low so that the Coase theorem applies, if the pesticide
companies own the lake, 20 tonnes of pesticide is produced. In this case the residents pay the company
to limit the dumping of waste.
25. If no one owns the lake and the government levies a pollution tax, what is the tax that achieves
the efficient outcome?
The tax is equal to the marginal external cost at the efficient quantity, which is $50 per tonne of
pesticide.
Use the following table to work Problems 26 to 28.
The first two columns of the table show the demand
Quantity
schedule for electricity from a coal burning power
Price demanded Marginal cost
company; the second and third columns show the
(cents per (kilowatts (cents per
company’s cost of producing electricity. The
kilowatt) per day) kilowatt)
marginal external cost of the pollution created is
4 500 10
equal to the marginal cost.
8 400 8
26. With no government action to control 12 300 6
pollution, what is the quantity of electricity 16 200 4
produced, the price of electricity, and the 20 100 2
marginal external cost of the pollution
generated?
With no pollution control, the quantity of electricity produced is 400 kilowatts per day, the price of
electricity is 8¢ per kilowatt, and the marginal external cost of the pollution generated is 8¢ per
kilowatt.
27. With no government action to control pollution, what is the marginal social cost of the electricity
generated and the deadweight loss created?
With 400 kilowatts of electricity being produced, the marginal social cost is 16¢ per kilowatt. To
calculate the deadweight loss, it is necessary to determine the efficient quantity of electricity. That
quantity is 300 kilowatts per day because that is the quantity at which the marginal social cost, 12¢ per
kilowatt, equals the marginal social benefit (the price from the demand curve, also 12¢). The
deadweight loss then equals the area of the triangle with a base equal to the difference between the
efficient quantity and the equilibrium quantity, 100 kilowatts, and a height equal to the marginal
external cost at the equilibrium quantity, 8¢ per kilowatt. The deadweight loss equals ½ × 100
kilowatts per day × 8¢ per kilowatt, which is $4 per day.
28. Suppose that the government levies a pollution tax, such that the utility produces the efficient
quantity. What is the price of electricity? What is the tax levied and the government’s tax
revenue per day?
The tax will equal the amount of the marginal external cost at the efficient quantity, 6¢ per kilowatt.
The quantity of electricity generated is 300 kilowatts per day and the price of electricity is 12¢ per
kilowatt. The government collects as revenue 6¢ per kilowatt × 300 kilowatts per day, which is $18 per
day.
29. Jet Skis Choking Coast Waterways

The Broadwater is struggling to cope with an explosion in the number of jet skis this summer.
Dealers were selling about 60 jet skis a week, and the Broadwater can barely manage. ‘Many
people who live on canals and along the river complain about the noise.
Source: Gold Coast Bulletin, 11 January 2011
a. What type of externality is created by jet ski riders on the Broadwater? Is the Broadwater being
used efficiently?
The Broadwater is a common resource for recreation; there is no excludability but there is rivalry.
When the waterway becomes overcrowded there is an inefficient use of a common resource because
the marginal private cost of using a jet ski is less than the marginal social cost. The marginal social
cost includes the marginal private cost of an extra jet ski plus the cost of the extra jet ski on other jet
ski users due to the increase in congestion. There is also the negative externality of noise pollution and
exhaust emissions from the jet skis.
b. Explain what policies the Gold Coast Council might adopt to deal with the complaints of the
canal homeowners.
The Gold Coast Council could privatise making jet ski riding illegal unless those wishing to use jet
skis on the Broadwater purchase a permit from the council. Alternatively, the Council could impose a
levy on jet ski riders.
The Tragedy of the Commons
30. Sydney Harbour on Boxing Day is congested with boats and yachts. Suppose that owners of
watercraft were required to pay a fee to sail on the harbour on Boxing Day.
a. Would the use of this common resource be more efficient?
Sydney Harbour is a common resource in those sections where it is nonexcludable and rival. The harbour
becomes rival when it becomes congested with boats and yachts. If there was a fee to sail on the harbour
on Boxing Day, its use would be more efficient.
b. Would it be even more efficient if the most popular parts of the harbour had the highest prices?
It would be even more efficient if the fee to sail on the harbour was higher in more popular areas because
these areas are more over-utilised than the less popular areas.
c. Why do you think we don’t see more market solutions to the tragedy of the commons?
It is probably the case that fees are not imposed because politicians resist imposing fees that their
constituents must pay on goods and services that had previously been “free”.
Use the following information to work Problems 31 to

33.
A spring runs under a village. Everyone can sink a well
on her or his land and take water from the spring. The
following figure shows the marginal social benefit from
water and the marginal cost of taking it.
31. What is the quantity of water taken and what is the
private cost of the water taken?
With no government intervention, the quantity of
water taken is 400 litres per day, determined in the
figure by where the marginal social benefit and the
marginal private cost curves intersect. The
marginal private cost of this quantity of water is
20¢ per litre.
32. What is the efficient quantity of water taken and
the marginal social cost at the efficient quantity?
The efficient quantity of water taken is 200 litres per day, determined in the figure by where the
marginal social benefit and the marginal social cost curves intersect. The marginal social cost of this
quantity of water is 30¢ per litre.
33. If the village council sets a quota on the total amount of water such that the spring is used
efficiently, what would be the quota and the market value of the water taken per day?
The quota would be set at 200 litres per day. This quantity of water would sell for a price of 30¢ per
litre, so the market value of this quantity of water is 200 litres × 30¢ per litre, which is $60.
34. Polar Ice Cap Shrinks Further and Thins
With the warming of the planet, the polar ice cap is shrinking and the Arctic Sea is expanding.
As the ice cap shrinks further, more and more underwater mineral resources will become
accessible. Many countries are staking out territorial claims to parts of the polar region.
Source: The Wall Street Journal, 7 April 2009
Explain how ownership of these mineral resources will influence the amount of damage done to
the Arctic Sea and its wildlife.
The Arctic Sea minerals might be privately owned, government owned, or owned by no one—common
resources. Regardless of who owns them, mining minerals creates pollution and disturbs marine life
habitat, which have external costs.
If the minerals are privately owned, then the quantity mined will be the amount that sets the marginal
private cost equal to the marginal private benefit. This quantity will have a deadweight loss because
the marginal social cost exceeds the marginal private cost.
If the minerals are government owned, then their allocation will be by majority vote. Lobbyists will
pressure elected officials to adopt their position in return for help with re-election. In this case, “green”
lobbyists and “business” lobbyists likely will square off. If the greens prevail, there is a possibility that
no minerals will be mined. This situation has a deadweight loss because less than the efficient quantity
is mined. If the business groups prevail, then there might be significant amounts mined. This situation,
similar, to the case of private ownership, has a deadweight loss because of overuse of the minerals.
Finally if the minerals are owned by no one, they become a common resource. In this case the quantity
mined will be that at which marginal private cost equals marginal private benefit. This quantity creates
a deadweight loss because the marginal external cost of damage to the Arctic Sea and also the
marginal social cost of resource depletion will be ignored.
35. After you have studied Reading Between the Lines on pp. 208–09, answer the following
questions:
a. What are the marginal private costs of and marginal private benefits from using biofuel rather
than fuel made from oil?
The marginal private costs of using biofuel in aircraft is the cost of the fuel used for an additional
passenger kilometre and the marginal private costs of using fuel made from oil is the cost of the fuel
used for an additional passenger kilometre. The marginal private costs of using biofuel rather than fuel
made from oil is the difference between the two.
The marginal private benefit is shown by the demand curve for air travel and is the same for both types
of fuel.
b. What are the marginal social costs of and marginal private benefits from using biofuel rather than
fuel made from oil?
The marginal social cost of using biofuel in an aircraft is the marginal private cost plus the marginal
external cost. The marginal external cost is the cost of the pollution from burning the fuel needed for
an additional passenger kilometre. The marginal social cost of using fuel made from oil is the marginal
private cost of the fuel plus the marginal external cost from burning the fuel. The marginal external
cost is the cost of the pollution from burning the fuel needed for an additional passenger kilometre.
The marginal social costs of using biofuel rather than fuel made from oil is the difference between the
two.
The marginal private benefit is shown by the demand curve for air travel and is the same for both types
of fuel.
c. How does a carbon tax help to achieve an efficient quantity of air transport?
Figure 9.9 shows what happens when a carbon
tax is imposed. The demand for air travel is D
and the airlines’ marginal private cost using
aviation fuel made from oil is MCoil = S0. At the
equilibrium price of $250 per trip and 20,000
passengers per month there is overprovision of
air travel and a deadweight loss. A carbon tax
equal to marginal external cost of carbon
emissions shifts the supply curve to the left to
MCoil + tax = S1, and the equilibrium quantity
decreases to 15,000 passengers a month, the
efficient quantity.
d. Why might a carbon tax end up generating
almost no tax revenue?
The airlines have an incentive to reduce their
costs by finding fuels that have a lower cost after tax. If biofuel is not taxed it becomes cheaper to use
than fuel derived from oil that is taxed and will be increasingly used by the airlines. If the airlines use
only biofuel there will be no tax revenue.
36. City Traffic Congestion a $20bn Problem

Australia’s big capital cities have been urged to introduce a London-style congestion tax payable
on entry into the CBD traffic or make city parking even more expensive so car commuters stop
taking everyone else for a ride. Parking levies have been introduced in Perth, Sydney and
Melbourne to raise money from private car parking operators and spend it on encouraging other
forms of transport into the cities.
Source: The Australian, 6 October 2010
a. Will a charge on cars entering the city make city streets less congested?
City streets become congested because they are a common resource—they are nonexcludable and once
congested, one person’s use of a congested road makes less of the road available for other users. If a
charge is made on cars entering the city it will mean the city streets are no longer a common resource,
cars that do not pay the charge will be excluded and the streets will be less congested.
b. Will a parking charge make city streets less congested?
A parking charge will to some extent reduce traffic on city streets as more people working in the city
opt to use public transport and shoppers will switch from city stores to suburban shopping centres.
c. Will a charge for entering the city be more effective than, less effective than, or equally effective
as a parking charge? Explain.
A parking charge is unlikely to be effective. Parked cars are not part of the traffic congestion and the
parking fee will have no effect on the through traffic, usually the main cause of congestion. Whether a
charge for entering the city is more, less or just as effective as a parking charge depends on the relative
charges. A charge for entering the city would be more effective if it reduced the congestion by more
than a parking charge would.
d. If a new road-use pricing system cuts travel times, will the road system be more efficient?
Explain.
When the city streets are congested the marginal private
cost to a driver is less than the marginal social cost
because the driver slows other drivers on the road thereby
imposing an external cost on them. A road-use charge
increases the private marginal cost of travel. Figure 9.10
shows the situation on a congested city street. The
marginal private cost curve, labelled MC lies below the
marginal social cost curve, labelled MSC. The marginal
private benefit equals the marginal social benefit and this
relationship is shown in the figure by the curve labelled
MSB. The efficient number of cars is 400 per hour and the
equilibrium number of cars is 600 per hour. A road-use
pricing system increases the private marginal cost of
travel. The charge shifts the MC curve upward and the
market-determined road use is more efficient. If the road-
use charge equals the marginal external cost at the
efficient number of cars, then the market outcome is efficient.

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Microeconomics Australia 7th Edition

McTaggart Solutions Manual

Answers to the Review Quizzes

Answers to the Study Plan Problems and Applications

Use the following news clip to work Problems 8 and 9.

Answers to the Additional Problems and Applications

29. Jet Skis Choking Coast Waterways

Use the following information to work Problems 31 to

36. City Traffic Congestion a $20bn Problem

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