Chapter 14
Environmental Economics
1. Private costs are
a. the full resource costs of an economic activity.
b. always less than social costs.
c. the costs of an economic activity borne by the producer.
d. All of the above answers are correct.
ANS
a. Incorrect. Private costs only include the producer’s resource costs. They exclude costs to
others, such as pollution.
b. Incorrect. If there are no external costs, private costs equal social costs. When we
conclude that ordinarily, competition is efficient, that conclusion is based on the assumption
that there are only private costs and no external costs.
c. Correct. Private costs include the cost of resources to the producer, such as land, labor,
and capital.
d. Incorrect. Only c. is a correct answer.
2. When negative externalities ,such as pollution exist, competition leads to
a. a socially efficient outcome.
b. too few goods being bought and sold.
c. a market equilibrium price that is too high.
d. more production than would be efficient.
ANS
a. Incorrect. The producer considers private costs only. It is necessary to consider social
costs, which include both private and external costs, to get a socially efficient outcome.
b. Incorrect. Competition leads to too many goods being produced and sold, as compared to
the socially efficient quantity.
c. Incorrect. Competition leads to a price below the socially efficient level.
d. Correct. Equating marginal private costs to marginal benefits, results in an inefficiently
large quantity.
3. From an economic viewpoint, the optimal amount of pollution
a. is zero because all pollution imposes costs on society.
b. is that amount which firms create when they maximize economic profits by setting their
marginal private costs equal to market price.
c. is that amount where the marginal social costs of producing a good precisely equals the
price of the good.
d. Both answers b. and c. are correct.
1
ANS
a. Incorrect. The optimal amount is the point where marginal social benefits equal marginal
social costs. This equality generally leads to the efficient quantity being greater than zero.
b. Incorrect. Firms fail to include external costs, and so produce more than the optimal
amount of pollution.
c. Correct. The optimal outcome is where marginal social benefits equal marginal social
cost. At equilibrium, price generally equals marginal social benefit, so there is optimal
pollution when P (= MSB) = MSC.
d. Incorrect. Only c. is correct; b. is incorrect.
4. Which of the following is the best example of a command-and-control regulation?
a. effluent taxes on pollutants.
b. emissions trading.
c. the requirement that automobiles to have catalytic converters.
d. Offset programs.
ANS
a. Incorrect. A tax is an incentive-based mechanism. It gives the firm the choice of how to
reduce pollution to reduce the amount of tax paid, or not reducing pollution and paying the
tax.
b. Incorrect. Emissions trading is an incentive-based approach. It gives the firm a choice of
how to reduce pollution to reduce the amount of permits needed and the opportunity to sell
excess permits, or not reduce pollution and the opportunity to buy additional permits.
c. Correct. A command-and-control program tells firms what they must do and how to do it.
In this case, it requires them to use the catalytic converter, even if there is a cheaper
technology available to accomplish the same goal.
d. Incorrect. Offsets are an incentive-based program. A company wanting build a factory in
a polluted area may be allowed to do so if it can reduce pollution elsewhere in the area. For
example, it could buy up enough high-pollution old cars and retire them to offset the
additional factory emissions.
Exhibit 6 Private and social cost
Social
MC
P1
L
Price K
(per unit)
•
• •
A
J
•
Social
ATC
G
Private
MC
• •
H
C
• •
F
E
B
Q1
Q2
Q3
Q4
Quantity of subscribers
(units per time period)
2
Private
ATC
5. The perfectly competitive profit-maximizing firm in Exhibit 6 creates water and air
pollution as a consequence of producing its output of pigs. If pollution costs are borne by
third parties, the firm will maximize economic profit by choosing to
a. voluntarily incur costs to reduce its pollution.
b. produce at output rate Q3.
c. produce at output rate Q2.
d. produce at output rate Q4.
ANS
a. Incorrect. Perfectly competition firms must choose to lowest-cost method of production if
they are to survive in the long run. If they are not required to consider pollution, they will
not do so.
b. Incorrect. Firms use marginal private costs, not average social costs, in making their
decisions.
c. Incorrect. Unless required to do so, competitive firms will not voluntarily include all
marginal social costs in making their output decision.
d. Correct. Unless required to consider pollution, competitive firms will produce where price
equals private marginal cost, which occurs at output level Q4.
6. Use Exhibit 6 to answer the following question. To maximize social welfare, the firm
should produce at which of the following output rates?
a. 0
b. Q.
c. Q3
d. Q4
ANS
a. Incorrect. No pollution likely means no pigs, a very high marginal cost. As there are
substantial benefits to pig products, zero output associated with zero pollution is not
generally efficient.
b. Correct. The socially efficient point is where P (=MSB) = MSC.
c. Incorrect. Firms use marginal private costs, not average social costs, in making their
decisions.
d. Incorrect. This output level includes only marginal private costs, and does not consider
the external costs of air and water pollution.
7. At the efficient level of pollution, the
a. total social costs and total social benefits of reduction are equal.
b. marginal social costs and marginal social benefits are equal.
c. marginal private costs and marginal private benefits are equal.
d. total private costs and total private benefits are equal.
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ANS
a. Incorrect. Society’s wellbeing is maximized where the difference between total social
benefits and total social costs are at a maximum, not when they are zero.
b. Correct. It is necessary to equate marginal social costs and marginal social benefits to
achieve the efficient point.
c. Incorrect. When there is pollution, it is necessary to consider social, not simply private,
benefits and costs.
d. Incorrect. The socially efficient point is where marginal social costs and marginal social
benefits, not total private costs and total private benefits, are equal.
8. A government policy that charges coal producers a fee per ton of coal produced (an
"effluent charge") where the fee is determined by the amount of pollutants discharged into
the air or water, will lead to a (an)
a. decrease in the market equilibrium quantity of coal produced.
b. decrease in the market equilibrium price of coal.
c. increase in the market equilibrium price of coal.
d. Both answers a. and c. are correct.
ANS
a. Incorrect. It is correct that the effluent charge will be seen by producers as an additional
production cost and so they will decrease supply. But a decrease in supply also leads to a
higher price, so both a. and c. are correct.
b. Incorrect. The effluent charge will lead to a decrease in supply, as producers will have
higher costs per ton of coal. The new equilibrium point will have a higher price per ton.
c. Incorrect. It is correct that the effluent charge will be seen by producers as an additional
cost, leading to a decrease in supply and a higher price. But there will also be a decrease in
equilibrium quantity, so both a. and. c. are correct.
d. Correct. The effluent charge will be seen by producers as an additional production cost
and so they will decrease supply. A decrease in supply leads to a decrease in equilibrium
quantity and a higher price, both a. and c.
9. Which of the following is an important lesson from the environmental experience in the
former Soviet Union?
a. Free-market economies are unlikely to have long-run environmental problems.
b. Government-owned industry tends to be cleaner than privately-owned industry.
c. Pollution can be worse in a communist system than in a capitalist system.
d. ollution can be worse in a capitalist system than in a communist system.
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ANS
a. Incorrect. If firms are not required to consider the environment, the outcome will be more
severe environmental problems that is socially efficient.
b. Incorrect. Soviet industry was state-owned, and yet pollution levels were far higher than
in free-market systems such as the United States, where most businesses are privately
owned.
c. Correct. Many rivers in the former Soviet Union were poisonous. The catastrophe at the
Chernobyl nuclear plant, where multitudes were exposed to nuclear radiation, is another
example of what some have called “ecoside”.
d. Incorrect. Levels of air and water pollution in the former Soviet Union were far higher
than in the U.S. Even today, a visitor to Beijing in China will breathe the equivalent of two
packs of cigarettes per day.
10. According to most economists, reducing automobile emissions to zero would be
a. optimal.
b. inefficient.
c. beneficial.
d. impossible.
ANS
a. Incorrect. At zero emissions, it is likely that the marginal social cost would be much
higher than the marginal social benefit. We would either have to forgo cars entirely, or use a
technology that would greatly increase the cost of automobiles.
b. Correct. At zero emissions, it is likely that the marginal social cost would be much higher
than the marginal social benefit. We would either have to forgo cars entirely, or use a
technology that would greatly increase the cost of automobiles.
c. Incorrect. At zero emissions, it is likely that the marginal social cost would be much
higher than the marginal social benefit. We would either have to forgo cars entirely, or use a
technology that would greatly increase the cost of automobiles.
d. Incorrect. To achieve zero emissions, we would either have to forgo cars entirely, or use a
technology that would greatly increase the cost of automobiles. It is feasible, but is unlikely
to be the socially efficient point.
11. In a perfectly competitive industry, which of the following is true?
a. The competitive price is higher and the quantity is higher than the socially efficient point.
b. The competitive price is higher and the quantity is lower than the socially efficient point.
c. Since the industry is perfectly competitive, price and quantity are at the socially efficient
levels.
d. The competitive price is lower and the quantity is higher than the socially efficient point.
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ANS
a. Incorrect. Competitive producers will base decisions on marginal private costs, which are
lower than marginal social costs if there are external costs. Their supply curve will be to the
right of socially efficient supply, resulting in a lower price and larger quantity than is
socially efficient.
b. Incorrect. Competitive producers will base decisions on marginal private costs, which are
lower than marginal social costs if there are external costs. Their supply curve will be to the
right of socially efficient supply, resulting in a lower price and larger quantity than is
socially efficient.
c. Incorrect. Unless the industry is required to do so, it will only consider marginal private
costs, not external costs. The outcome will be privately efficient, but not socially efficient.
d. Correct. Competitive producers will base decisions on marginal private costs, which are
lower than marginal social costs if there are external costs. Their supply curve will be to the
right of socially efficient supply, resulting in a lower price and larger quantity than is
socially efficient.
Each time Orville flies over Wilbur's house, the noise reduces the value of Wilbur's house.
Exhibit 7 shows the profits to Orville of each flight, and the value of Wilbur's house at each
flight.
Exhibit 7 Impact of flights on house value
Number of
flights
1
2
3
4
5
Total
profits
$10,000
18,000
24,000
28,000
30,000
Marginal
profits
$10,000
8,000
6,000
4,000
2,000
Value of Wilbur's
house
$100,000
95,000
90,000
85,000
80,000
12. As shown in Exhibit 7, if Orville has the property right to fly over Wilbur's house, but
Wilbur is allowed to negotiate with Orville on the number of flights, what will be the
number of flights?
a. 2
b. 3
c. 4
d. 5
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ANS
a. Incorrect. Wilbur will offer as much as $5000 to reduce the number of flights from 3 to 2.
But Orville would lose $6000 if the third flight is forgone.
b. Correct. Wilbur is willing to pay as much as $5000 to reduce the number of flights.
Orville will gain from accepting money from Wilbur as long as the amount exceeds what he
would get in marginal profit from an additional flight. Marginal profit is less than $5000 for
flights 4 and 5, but not for the third flight.
c. Incorrect. Reducing the number of flights from 4 to 3 will cost Orville $4000 in forgone
profits, and is worth $5000 to Wilbur in increased house value. They will negotiate a
reduction in the number of flights below 4.
d. Incorrect. The fifth flight adds $2000 to Orville’s profits, but costs Wilbur $5000 in lost
house value. Wilbur will be able to compensate Orville for forgoing the fifth flight.
13. As shown in Exhibit 7, if Wilbur has the property right to have no planes flying over his
house, but Orville is allowed to negotiate with Wilbur, what will be the number of flights?
a. 2
b. 3
c. 4
d. 5
ANS
a. Incorrect. Orville will be able to get Wilbur to agree to more than 2 flights. He is willing
to pay as much as $6000 for the third flight, enough to compensate Wilbur for $5000 in lost
house value.
b. Correct. Orville will be able to compensate Wilbur for permitting flights 2 and 3, but not
4. He will pay up to $8000 for flight 2, which will compensate Wilbur for a $5000 loss in
house value. He will pay $6000 for flight 3, again enough to cover $5000 in lost house
value. But he will pay only $4000 for flight 4, less than the $5000 in lost house value.
c. Incorrect. Wilbur will be willing to pay a maximum of $4000 for the fourth flight, not
enough to compensate Wilbur for a $5000 loss in house value.
d. Incorrect. Wilbur will be willing to pay a maximum of $2000 for the fifth flight, not
enough to compensate Wilbur for a $5000 loss in house value.
14. As shown in Exhibit 7, at the socially efficient number of flights, what will be the
market value of Orville's house?
a. $100,000.
b. $95,000.
c. $90,000.
d. $85,000.
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ANS
a. Incorrect. More than one flight is efficient, resulting in a lower house value than $100,000
b. Incorrect. This house value corresponds to 2 flights. A third flight would reduce house
value by $5000, but would add profit of $6000. The point where the house is worth $90,000
cannot be efficient.
c. Correct. The efficient number of flights is 3, and the corresponding house value is
$90,000. Note that the sum of Orville’s profits and Wilbur’s house is $114,000 at this point,
and no other point gives as high a total.
d. Incorrect. The fourth flight, which corresponds to a house value of $85,000, is not
efficient. It reduces the value of Wilbur’s house by $5000, while only costing Orville $4000.
15. According to the Coase Theorem, the private sector can achieve social efficiency if the
government
a. establishes and enforces property rights.
b. imposes taxes to serve as proxies for external costs.
c. sets rigorous environmental standards.
d. encourages competition with antitrust laws.
ANS
a. Correct. The government, primarily through the court system, clearly states who owns
what, and then leaves it to the private parties to negotiate any changes. They will be able to
negotiate successfully if they both gain from a change, an increase in efficiency. Once they
reach the efficient point, they will not be able to negotiate any further mutually beneficial
exchanges.
b. Incorrect. Taxes are the approach suggested by Pigou.
c. Incorrect. Coase leaves it to the parties to determine how much environment they want
and are willing to pay for.
d. Incorrect. The Coase Theorem applies most directly to two-party exchanges. As the
number of parties increases, such as in competition where there are many firms, it becomes
more difficult to negotiate an agreement.
16. The costs of an economic activity borne by the producers are
a. always less than social costs.
b. the full resource costs of an economic activity.
c. private costs.
d. All of the above answers are correct.
ANS
a. If there are no externalities, private costs and social costs are equal.
b. Producers consider private, but not external, costs. If there are externalities, the producer
will not include those costs unless required to do so.
c. Correct. Private costs include production costs from the producer’s perspective, such as
the costs of capital and labor.
d. Only c. is correct.
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17. An example of the command-and-control approach to environmental policy is
a. placing a tax on Freon to reduce its use and the corresponding CFC emissions (which
contribute to the ozone hole).
b. requiring car producers to install new air conditioners that do not use Freon.
c. allowing coal producers to buy and sell permits to allow CFC emissions.
d. allowing individuals to sue Freon producers if CFC emissions exceed a government-set
standard.
ANS
a. Taxes are an incentive-based approach. The producer can then choose to reduce its
emissions of Freon, or not reduce its emissions and pay a tax.
b. Correct. Under CAC, the government tells companies what to do and how do it.
c. Emissions trading is an incentive-based approach. Producers can reduce their Freon
emissions, or not reduce their emissions and buy additional permits to pollute.
d. This approach is not an example of CAC. The government is not telling producers what to
do and how to do it.
18. If a good is produced up to the point where marginal social benefit equals marginal
social cost, then
a. social welfare is maximized.
b. the good is overproduced and the market is inefficient.
c. firms are earning zero profits.
d. all externalities have been eliminated.
ANS
a. Correct. The condition MSB = MSC is the condition that maximizes social welfare.
b. Incorrect. If there are externalities, but society equates MPB = MPC, the good will be
overproduced because external costs are being ignored.
c. Incorrect. There is no guarantee that firms will earn a zero profit.
d. Incorrect. The efficient point for society is likely to correspond to a lower level of
externalities than would be achieved by a private market where there is no government
intervention. But the costs of achieving zero externalities are likely to be more than society
is willing to pay.
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Jack enjoys smoking, while Jill fears that second-hand smoke will shorten her life. Exhibit 8
shows the value Jack places on each cigarette he smokes, and the value Jill places on her
shortened life. Use the table to answer the following questions
Exhibit 8 Cigarette smoking data
Quantity of
cigarettes
1
2
3
4
5
Total value to Jack of
cigarettes
$ 50
90
120
140
150
Days of life
lost
1
2
3
4
5
Total value to Jill of
days lost
$ 30
60
90
120
150
19. As shown in Exhibit 8, if smokers have the right to smoke as many cigarettes as they
wish, and non-smokers have the right to negotiate, how many cigarettes will Jack smoke?
a. 1
b. 3
c. 5
d. more than 5
ANS
a. Incorrect. Jill will not be able to get Jack to cut back to one cigarette. Jack will need at
least $40 to cut back from two cigarettes to one, but Jill is willing to pay no more than $30.
b. Correct. It is worth $30 to Jill if Jack will not smoke the 5th cigarette, and is worth only
$10 to Jack to smoke it. Similarly, she will be able to pay Jack not to smoke a 4th cigarette.
c. Incorrect. Jill is willing to pay up to $30 if Jack doesn’t light up the fifth cigarette. As Jack
gets only $10 of enjoyment, Jill will offer him between $10 and $30 to not light up.
d. Incorrect. Cigarettes beyond the fifth will give Jack diminishing enjoyment. Assuming
that Jill’s cost remains at $30, she would be able to pay Jack not to smoke more than five
cigarettes.
20. As shown in Exhibit 8, what is the socially efficient number of cigarettes?
a. 0
b. 1
c. 3
d. 5
10
ANS
a. The first cigarette is worth $50 to Jack, more than the $30 it costs Jill. So it is efficient for
Jack to smoke at least one cigarette.
b. The second cigarette is worth $40 to Jack, more than the $30 it costs Jill. So it is efficient
for Jill to smoke at least two cigarettes.
c. Correct. Jill is willing to pay Jack $30 to not smoke the fourth cigarette, which is enough
to compensate him for $20 in foregone enjoyment. But $30 is not enough for him to forgo
the second cigarette, which is worth $40 to him.
d. Jack values the fifth cigarette at $10, less than the $30 it costs Jill. Cigarettes beyond the
fifth will have even less value to Jack, so they are not efficient.
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