REVIEW QUESTIONS
1. Economic efficiency is attained when no Pareto improvements are possible.
2. a. A Pareto improvement. This is a voluntary exchange, so both parties must
benefit.
b. A Pareto improvement. Going to the movie is a voluntary decision for both
you and your friend, so both of you must gain.
c. Not a Pareto improvement (since you were harmed), although this could
become a Pareto improvement if your friend compensates you for your
loss through a side payment.
3. In a perfectly competitive market with no market failure, providing less than
the equilibrium quantity cannot be economically efficient, because provision
of an extra unit of the good increases total net benefits.
4.
In a perfectly competitive market with no market failure, providing more than
the equilibrium quantity cannot be economically efficient, because reducing
output by one unit will increase total net benefits.
5.
False. A price of $0 would maximize market consumer surplus. The
economically efficient price maximizes the sum of market consumer surplus
plus market producer surplus.
6.
a. Criminal law limits exchanges to those that are voluntary. Voluntary
exchanges lead to Pareto improvements. Involuntary exchanges, such as
robbery, always harm at least one party.
b. Property law gives precisely defined, enforceable rights over goods. If
property rights are poorly defined, people waste resources trying to take
away another person’s property—an activity that makes at least one party
worse off—instead of devoting resources to Pareto improvements.
c. Contract law enhances efficiency by extending the range of Pareto
improvements that can take place. In particular, it enables Pareto
improvements that involve the future actions of some other party.
d. Tort law deals with relationships between people or businesses not linked
by contracts. It creates incentives for businesses and individuals to account
for the effects of their actions on others, thereby engaging in fewer acts
that hurt others, and enhancing efficiency. Tort law also protects against
fraud, thereby reducing the transactions costs associated with doing
business.
e. Antitrust law helps sustain and improve competition in industry by
preventing certain practices that would limit competition and prevent
Pareto-improving production from taking place.
7.
The three major types of market failure discussed in the chapter are monopoly
power, externalities, and the existence of public goods. Antitrust legislation or
regulation could correct monopoly power. Taxes, regulation, and tradable
permits could correct externalities. Government provision of public goods
could correct the failure of markets to provide these goods.
8.
The Coase theorem addresses market failure due to externalities. When side
payments can be negotiated and arranged without cost, the private market will
solve the externality problem on its own.
9.
In the case of negative externalities, if the free rider problem is extensive
enough, it can shrink the side payment to losers until it isn’t large enough to
compensate losers and still leave the gainers better off. In that case, the private
arrangement will break down and the efficient outcome will not be achieved.
In the case of positive externalities, the free rider problem keeps individuals
from voluntarily making side payments to provide a good to strangers. Again,
if it is extensive enough, side payments won’t be large enough to provide the
good in efficient quantities.
10. Marginal cost measures the cost to the producer of producing another unit of a
good, while marginal social cost measures the full cost of producing another
unit of a good, including the marginal cost to the producer and any harm
caused to third parties.
11. The Coase theorem does not apply to most cases of air pollution because of
the large number of people involved—it is very costly to determine the gains
and losses for each one, get them all together, and then develop a solution that
would please everyone.
12. A pure public good is one that is nonrival—consumption by one person does
not affect the amount available to be consumed by others—and
nonexcludable—there is no way to force consumers to pay for the good. A
pure private good, by contrast, is rival and excludable.
13. a. Breakfast at a coffee shop: mostly excludable; mostly rival
b. Medical care to treat a highly contagious disease: mostly excludable
(although considerable benefits also accrue to the population at large
which is less likely to catch the disease); mostly nonrival
c. Efforts to maintain homeland security: mostly nonexcludable; mostly
nonrival
d. A movie shown in a theater with mostly empty seats: mostly excludable;
mostly nonrival
e. Teaching young children not to steal: mostly nonexcludable (most of the
benefits accrue to others who do not “pay” by taking the time to teach their
children not to steal); mostly nonrival