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Excercise For Externality (Answer)

The document discusses externalities from factory pollution and cigarette smoking. It provides examples of negative externalities and discusses how markets can be inefficient in the presence of externalities. It also provides a numerical example calculating market equilibrium with and without an externality and the potential gains from a corrective tax.

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Khin Thandar Hlaing
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26 views

Excercise For Externality (Answer)

The document discusses externalities from factory pollution and cigarette smoking. It provides examples of negative externalities and discusses how markets can be inefficient in the presence of externalities. It also provides a numerical example calculating market equilibrium with and without an externality and the potential gains from a corrective tax.

Uploaded by

Khin Thandar Hlaing
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Khin Thandar Hlaing(Myanmar)

Student ID- PMW202154004


1. “Smoke from a factory dirties the local housing and poisons crops.”
Identify the nature of the externalities in this statement.
Factories make useful products, but they also make waste. Unfortunately, factory
owners do not always dispose of waste safely. Factories often put dangerous
chemicals and other dangerous materials into the air, water, and ground. Smoke
from factory waste causes serious health problems for everyone in the community,
and when it travels in air and water, can even cause illness for people who live
hundreds of miles away. So, the smoke dirtying the local housing is negative
consumption externality and the smoke that poisons the crops is negative
production externality.
2. Are the following statements true or false? Explain why
a. If your consumption of cigarettes produces negative externalities for your
partner (which you ignore), then you are consuming more cigarettes than is
Pareto efficient.

TRUE. With negative externalities the market equilibrium quantity in general


exceeds the Pareto-efficient level. By smoking in public, smokers force other
individuals to breathe air with smoke, known as second-hand smoke. In addition,
the health problems associated with smoking force society to pay higher health
care costs to pay for smoking related illnesses, both for smokers and for those who
breathe second-hand smoke, than if no one in society smoked.

b. It is generally efficient to set an emission standard allowing zero pollution.

FALSE. If some production process generates a nonzero level of pollution, but the
benefits exceed the cost. Then this production is socially optimal and should be
allowed. Hence the emission standards should allow for a certain nonzero pollution
level.
c. A tax on cigarettes induces the market for cigarettes to perform more
efficiently

TRUE. Smoking generates negative externalities, and the market outcome is


efficient.
d. A ban on smoking is necessarily efficient.
FALSE. A ban on smoking reduces the utility of the smokers and the profits of the
cigarette makers. The utility of nonsmokers and the profits of the producers of
substitute goods (chewing tobacco) will increase. The effect on aggregate welfare
function is the sum of these offsetting effects and may be positive or negative.
e. A competitive market with a negative externality produces more output
than is efficient.
True. Because the firms in the industry do not take into account the external costs
associated with production and they only take into account their private costs.

f. A snob effect is a negative (network) externality from consumption


True. A snob effect is a negative network externality. The snob effect refers to the
desire to own exclusive or unique goods. The fewer the people who own a snob
goods, the higher is the quantity demanded of this goods.
3. A competitive refining industry releases one unit of waste into the
atmosphere for each unit of refined product. The inverse demand function for
the refined product is pd = 20−q, which represents the marginal benefit curve
where q is the quantity consumed when the consumers pay price pd . The
inverse supply curve for refining is MPC = 2 + q, which represents the
marginal private cost curve when the industry produces q units. The marginal
external cost
curve is MEC = 0.5q, where MEC is the marginal external cost when the
industry releases q units of waste. Marginal social cost is given by MSC =
MPC + MEC.
a. What are the equilibrium price and quantity for the refined product when
there is no
correction for the externality?
b. How much of the refined product should the market supply at the social
optimum?
c. How large is the deadweight loss from the externality?
d. Suppose that the government imposes an emission fee of T per unit of
emissions. How large must the emission fee be if the market is to produce the
socially efficient amount of the refined product?
a) If there is no correction for the externality, the equilibrium will occur at the
point where the marginal benefit curve, pd = 20 −q , the marginal private cost
curve,
MPC = 2 +q. This occurs at
20 - q = 2+q
2q = 18
q =9
At q =9, price is p =11.

b) At the social optimum marginal benefit, pd = 20 −q , will equal marginal social


cost,
MSC = MPC +MEC . This occurs where

20 - q = (2 + q) + 0.5q
-2.5 q = - 18
q = 7.2
Thus, the social optimum is to produce q = 7.2

c) At the uncorrected equilibrium, the marginal social cost is MSC = 2 +1.5(9)


=15.5 .

d) The emissions fee of $T should be set to shift the MPC curve so that it intersects
the
marginal benefit curve at q = 7.2 , the socially optimal quantity. At q = 7.2 the
marginal benefit is P =12.8 and the marginal private cost is MPC = 2 +7.2 =9.4 .
Therefore, the optimal tax is T =12.8 −9.4 = 3.4.
4. Why is there more litter along highways than in people’s yards?
Littering on a highways usually has no direct economic impact on a person's life.
However, littering in a person's back yard reduces the property value of a home.
People are less likely to buy a home with litter on it, and houses with litter in their
backyards may be valued at a lower price than those that do not. Additionally, litter
in one's backyard may cause illness. Illness leads to many economic problems,
including medical bills.
5. Evaluate the following statement “Since pollution is bad, it would be
socially optimal to prohibit the use of any production process that creates
pollution”
The statement I thought that is not true. Pollutions yield both benefits and costs to
society. But in a market economy without government intervention, those who
benefit from pollution like the owners of power companies decide how much
pollution occurs. They have no incentive to take into account the costs of pollution
that they impose on others. The costs of pollution, though, fall on people who have
no say in the decision about how much pollution takes place: people who fish in
northeastern lakes do not control the decisions of power plants.
6. Education is often viewed as a good with positive externalities.
a. Explain how education might produce positive external effects.
b. Suggest a possible action of the government to induce the market for
education to perform more efficiently.
a. Education increases labor productivity by raising the skill of the labor force.
Education lead to higher output and higher national income from which everyone
benefits.
Heavy investments are required in building modern schools in remote towns and
villages. Good quality education should be within the easy reach of every child.
Every school must be equipped with modern teaching aids and strong internet
bandwidth. The concept of ‘smart class’ needs to be promoted widely. The idea is
that every school offers the same standard and quality of education across the
country.  

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