Practice Questions #10

Question 1:

Identify whether the following are positive consumption externalities, negative consumption externalities, positive production externalities, or negative production externalities:

• Your neighbor listens to music loudly in his own apartment.
• Your neighbor hires a leaf blower to get rid of the leaves on the street.
• One of your fellow students puts together her lecture notes while studying for the exam and lets you xerox them.
• The farmers in the rural areas of Turkey burn the forests on purpose to clear land for their agricultural activities.
• One of the two factories, which are located adjacent to each other by a river and pollute it, decides to clean up the river as a result of new government regulations and thinks of using this as a part of its new ad campaign.

Question 2:

Bob, Ed and Jane live on Short Street. They decided to build a small park at the corner of the street right by the lake. They each have a different demand curve for the park given by the following equations:

  Bob: P = 60 - Q
  Ed: P = 45 - Q
  Jane: P = 45 - 2Q

The marginal cost of building the park is given by MC = Q where Q represents the area in terms of square feet that will be allocated for the park.

• What is the optimal area to be allocated for the park?
• What is the total price paid to provide the park?
• Of this price, Bob will pay ______ , Ed will pay ______ , and Jane will pay ______ .
• Will this optimal amount of the public good necessarily be provided by the residents of Short Street? Explain.

Question 3:

Watertown is a small town surrounded by many small lakes. The major economic activity in town is ice fishing and during winter, people from other towns in the area come to Watertown for ice fishing. The town council decides to sell ice fishing rights to extract some revenues and to discourage some of the ice-fishing activity since this activity is damaging the ecosystem. It is estimated that the demand for these rights is given by the following equation: P = 250 - Q while the marginal cost of issuing the rights by the council is given by MC = Q.

• Comment on whether there exists any inefficiency in ice fishing before the rights were issued.
• Find the equilibrium price and quantity for ice-fishing rights.
• One of the members of the council, Mr. Smith, thinks that there are external costs involved with selling the rights to ice fishing. He claims that before the rights were sold, there were more people coming to Watertown for ice fishing and this was very helpful for the local merchants. He estimates that because the rights discourage people from coming to town, the net loss of merchants amount to 10 + Q. Considering the market for ice-fishing rights, is this a consumption externality or a production externality?
• Assuming Mr. Smith's estimate is correct, find the socially efficient quantity and price of ice fishing rights.

Question 4:

Which of the following statements is TRUE?

• A positive consumption externality arises when marginal social benefit is greater than marginal private benefit.
• A negative consumption externality arises when marginal social benefit is lower than marginal private benefit.
• A positive production externality arises when marginal social cost is lower than marginal private cost.
• A negative production externality arises when marginal social cost is greater than marginal private cost.
• All of the above.

Question 5:

Overfishing in the oceans can be eliminated by

• assigning long-term exclusive rights for fishing.
• issuing marketable permits for fishing.
• taxing fishing boats.
• Both (B) and (C).
• (A), (B), and (C).

Question 6:

If there is a negative production externality in the market for good X, then

• good X should never be produced.
• good X will be underproduced in the market.
• good X will be overproduced in the market.
• the government should give a subsidy to the producers of good X.
• the government should subsidize the consumers of good X.