Homework 10: Externalities (to be handed in on Thursday 29th April 2004)
1. Which of the following describes an externality and which does not? Explain your answer (1
point)
a) A policy of restricted coffee exports in Brazil causes the US price of coffee to rise – an
increase which in turn also causes the price of tea to rise.
b) An advertising blimp distracts a motorist who then hits a telephone pole.
c) Planting flowers in your front garden.
2. Compare and contrast the following three mechanisms for treating pollution externalities
when the costs and benefits of abatement are uncertain: a) an emission fee; b) an emissions
standard; c) a system of transferable emissions permits (1.5 points)
3. Suppose a clothing factory is located downwind from a copper smelting plant. The copper
smelting plant emits particulates into the air that cause $100,000 in damage per year to the
clothing factory in terms of fabric discoloration. The plant could eliminate its emissions by
installing a superior scrubbing technology at a cost of $50,000 per year. Existing regulations
do not prohibit the emission of these particulates. The only way to remedy this inefficiency is
through government intervention. True or false? Explain your answer (1 point)
4. The United Nations Kyoto Protocol of1997 requires most industrial nations to reduce their
carbon dioxide and other greenhouse gas emissions during the ensuing decade to about 5% of
1990 levels. Explain why such a policy is inefficient. (1 point)
5. Using an example, explain why free access to a common resources generates an inefficient
outcome (1 point)\
6. Public television is funded in part by private donations even though anyone with a TV set can
watch for free? Can you explain this phenomenon in light of the free rider problem? (1 point)
7. Assume that scientific studies provide you with the following information concerning the
benefits and costs of sulfur dioxide emissions, where A is the quantity abated in millions of
tons (1.5 points):
Benefits of abating (reducing) emissions:
Costs of abating emissions:
MB = 400 – 10A
MC = 100 + 20A
a) What is the socially efficient level of emissions abatement?
b) What happens to net social benefits (benefits minus costs) if you abate one million more tons
than the efficient level?
c) Why is it socially efficient to set marginal benefits equal to marginal costs rather than abating
until total benefits equal total costs?
8. Initially, the styrofoam cup industry produces with a constant marginal cost of $4. The
market demand for its product is given by P = 22 – Q. Suppose the industry produces air
pollution along with cups. These pollution costs are represented by the marginal external cost
function, MEC = 0.2Q. Draw a graph to illustrate this scenario, using your answers to the
questions below. (2 points)
a) What output will the free market choose to produce? What is total welfare (the sum of CS
and PS)?
b) Given the pollution costs, how many styrofoam cups should be produced from society’s point
of view?
c) The EPA requires the industry to adopt a new “lower pollution production technology” that
raises the marginal cost of production to MC = $10. Given this required new technology,
how much will the industry produce? What is the sum of CS and PS at this point?
d) A consulting firm estimates the total benefits of reducing pollution using this new technology
at $80. Is the reduction in pollution worth its costs to the producers and consumers of
styrofoam cups?