Deck 13: External Costs and Benefits

Question 1

Pigou taxes are unnecessary in the presence of transaction costs.

Answer 1

False

Question 2

A free-rider problem occurs when people can share in the benefits of an activity without being forced to contribute to its costs.

Answer 2

True

Question 3

Strict liability is the liability that exists when it can be proven beyond a reasonable doubt that the defendant was negligent.

Answer 3

False

Question 4

In the absence of transactions costs,changes in property rights have no effect on the distribution of income.

Question 5

In the absence of transactions costs,changes in property rights have no effect on economic efficiency.

Question 6

Transaction costs arise when property rights are nonexistent.

Question 7

Court decision involving torts are irrelevant to social welfare.

Question 8

Changes in property rights will not affect the allocation of resources as long as transactions costs are zero and the subsequent effects on market demand are negligible.

Question 9

Social costs are felt by consumers but not by manufacturers.

Question 10

A Cap and Trade system is more prone to error than a Pigou tax.

Question 11

If all parties can enter into negotiations,social optimum is achieved with or without a Pigou tax.

Question 12

A Pigou tax forces car manufacturers to internalize the cost of pollution.

Question 13

The weak Coase theorem is true when reallocation of property rights have negligible income effects .

Question 14

A negligence standard,with the allowance of contributory negligence,always leads to a socially optimal outcome.

Question 15

All cars contribute positively to social gains.

Question 16

Social costs are equal to the costs imposed on others.

Question 17

In the principal-agent problem,assigning full liability to the agent gives no incentive for the principal to avoid damages.

Question 18

According to the Coase Theorem,in the absence of transactions costs,recipients of an external benefit can be expected to offer a bribe in exchange for greater production.

Question 19

Pigovian analysis indicates that a subsidy should be awarded when economic activity creates social benefits.

Question 20

Cap and Trade is so named because the government puts a "cap" on the amount of exports that domestic firms are allowed to "trade" with foreign nations.

Question 21

According to Coase's analysis,when are private costs and social costs the same?

A) Always.
B) When there are no transactions costs.
C) When property rights are clearly defined.
D) Never.

Question 22

According to Pigou,the socially optimal quantity

A) is Q_O
B) is Q_E
C) eliminates area A+B+C+D.
D) creates area E.

Question 23

Pollutants

A chemical plant's production adds pollutants to a stream which irrigates a farm's crops. The pollutants damage the farm's crops, increasing the firm's costs by $800 per month. The crop damage may be eliminated in two ways: the chemical plant can install a new filtering system costing $300 per month, or the farm can install a new irrigation system costing $600 per month.



-Refer to Pollutants.Suppose transactions costs are zero.Also suppose the chemical plant is not liable for the farm's crop damages and can continue to pollute the stream.What will be the result of private bargaining between the farm and the chemical plant?

A) The chemical plant will pay the farm $800 per month in crop damages.
B) The farm will bear the $800 per month cost of crop damages.
C) The chemical plant will install the new filtering system.
D) The farm will install the new irrigation system.

Question 24

Negligence is irrelevant when a strict liability standard is applied.

Question 25

The doctrine of Respondent Superior contends that an employer is sheltered from torts committed against his employees.

Question 26

According to Pigovian analysis,competitive behavior will result in overproduction of a good when

A) firms' activities create external costs.
B) people outside of market transactions benefit from those transactions.
C) property rights have been clearly and unambiguously assigned.
D) private and social marginal costs are identical.

Question 27

The principle of general average gives a ship's captain an incentive to consider the value of cargo when jettisoning it to prevent a disaster.

Question 28

Pollutants

A chemical plant's production adds pollutants to a stream which irrigates a farm's crops. The pollutants damage the farm's crops, increasing the firm's costs by $800 per month. The crop damage may be eliminated in two ways: the chemical plant can install a new filtering system costing $300 per month, or the farm can install a new irrigation system costing $600 per month.



-Refer to Pollutants.Suppose transactions costs are zero.Who should be made liable for the crop damage if the goal is to achieve an efficient outcome?

A) The chemical plant should be made liable,because it is the source of the pollution.
B) The chemical plant should be made liable,because it possesses the least-cost method of eliminating the externality.
C) The farm should be made liable,because it can receive a bribe from the chemical plant.
D) An efficient outcome will be achieved no matter who is made liable for the crop damage.

Question 29

A Pigovian tax internalizes an external cost because

A) the cost then enters the decision-making process of the producer.
B) it would be collected by the Internal Revenue Service.
C) the revenue is used to compensate injured parties.
D) no transactions costs are created.

Question 30

Negative Externality

The following questions refer to the accompanying diagram, which shows the effects of a negative externality created by an industry's production. The equilibrium quantity in the absence of any attempt to internalize the externality is QE, and the optimal quantity according to a Pigovian analysis is QO.


-Refer to Negative Externality.Suppose there are no transactions costs.Also suppose the externality is internalized when the damaged parties offer producers a bribe of $5 per unit to reduce their production.Coase's analysis indicates that social gain in this situation will equal

A) area A + B + F.
B) area A + B + F - E.
C) area A + B + C + D + F + G + H.
D) area A + B + C + F + G.

Question 31

What does it mean to say that a firm has been made liable?

A) The firm is legally responsible to compensate other parties for damage.
B) The firm has begun to treat any external costs as private costs.
C) The firm has received the property rights to a disputed resource.
D) The firm is required to pay a Pigou tax to the government.

Question 32

Negative Externality

The following questions refer to the accompanying diagram, which shows the effects of a negative externality created by an industry's production. The equilibrium quantity in the absence of any attempt to internalize the externality is QE, and the optimal quantity according to a Pigovian analysis is QO.


-Refer to Negative Externality.According to a Pigovian analysis of this externality,when a tax of $5 per unit is imposed on the firms in this industry,the external costs created by the firms' production will equal

A) area C + D + E + G + H.
B) area C + D + G + H.
C) area C + G.
D) zero.

Question 33

Coase argues that every case of externalities

A) has a clearly identifiable cause.
B) requires government intervention if efficiency is to be achieved.
C) can be traced back to a principal-agent problem.
D) is reciprocal in nature.

Question 34

Pollutants

A chemical plant's production adds pollutants to a stream which irrigates a farm's crops. The pollutants damage the farm's crops, increasing the firm's costs by $800 per month. The crop damage may be eliminated in two ways: the chemical plant can install a new filtering system costing $300 per month, or the farm can install a new irrigation system costing $600 per month.



-Refer to Pollutants.Suppose transactions costs preclude the possibility of private bargaining between the chemical plant and the farm.Which liability rule will not result in an efficient outcome?

A) The chemical plant bears all liability for the crop damage.
B) The farm bears all of the costs of the crop damage.
C) The chemical plant bears 50% of the liability,while the farm bears the other 50% of the crop damages.
D) The Coase Theorem guarantees that any assignment of liability will result in an efficient outcome.

Question 35

The Good Samaritan Rule dictates that if a person witnesses a crime,they must assist the person against whom the crime is being committed.

Question 36

Smith' s construction of an 8-foot fence around his property will block his neighbor Johnson's scenic view.If Smith constructed a 6-foot fence,Johnson's view would not be blocked.If Johnson values his view at $1,000 and Smith values the extra 2 feet of fence at $500,then a possible resolution is that

A) Johnson makes a side payment to Smith of $750 not to build the fence so high.
B) Johnson makes a side payment to Smith of less than $500 not to build the fence so high.
C) Smith makes a side payment of $750 to Johnson to live with the fence.
D) Smith makes a side payment of over $1000 to Johnson to live with the fence.

Question 37

According to Pigovian analysis,when is a tax necessary to improve the market's economic efficiency?

A) When high transactions costs prevent private bargaining.
B) When the social marginal cost of production exceeds the private marginal cost.
C) When consumption of the good creates external benefits for others.
D) When at the competitive equilibrium,the social marginal benefit of the good equals its social marginal cost.

Question 38

Negative Externality

The following questions refer to the accompanying diagram, which shows the effects of a negative externality created by an industry's production. The equilibrium quantity in the absence of any attempt to internalize the externality is QE, and the optimal quantity according to a Pigovian analysis is QO.



-Refer to Negative Externality.Suppose there is no attempt to internalize the externality.Pigovian analysis indicates that the externality creates a deadweight loss equal to

A) area C + D + E + G + H.
B) area D + E + H.
C) area C + D + G + H.
D) area E.

Question 39

Any cost of negotiating or enforcing a contract is

A) an external cost.
B) a private cost.
C) a transaction cost.
D) a side payment.

Question 40

External costs are

A) negative externalities and are subtracted from marginal private costs to find marginal social costs.
B) negative externalities and are added to marginal private costs to find marginal social costs.
C) positive externalities and are added to marginal private costs to find marginal social costs.
D) positive externalities and are subtracted from marginal private costs to find marginal social costs.

Question 41

The Pacific Pulp Company plans to clearcut 100 acres of land to produce paper pulp which would earn the firm $50,000 in profits.One hundred nearby homeowners realize that this would reduce the value of each of their properties by $1,000.These 100 homeowners

A) face a logistical problem of getting together to offer a bribe to Pacific Pulp.
B) would not benefit from offering any side payment to Pacific Pulp not to clearcut.
C) have no legal option except to suffer the damages to their property values.
D) can costlessly organize to offer Pacific Pulp a side payment not to clearcut.

Question 42

According to the Strong Coase Theorem,when will the assignment of property rights have no effect on the allocation of resources?

A) Always.
B) When there are no transactions costs.
C) When there are no transactions costs and changes in the distribution of income do not have significant effects on market demand curves.
D) When liability is assigned to the party with the least-cost method of dealing with an externality problem.

Question 43

A defendant forced to pay punitive damages must pay the plaintiff

A) the exact amount of actual damage.
B) more than the amount of actual damage.
C) less than the amount of actual damage.
D) nothing.

Question 44

Redding Railroad is held liable by the courts for damages to crops growing along its lines caused by sparks flying off when trains pass.The court ordered damage assessment is $100 per adjoining acre though profits per acre are less than this.Currently,about half of the line has adjoining planted farmlands,the other half is not yet developed.As a result

A) farmers are likely to reduce the number of acres they plant.
B) farmers are likely to increase the number of acres they plant in order to collect the payment.
C) the railroad will increase the number of trains running.
D) farmers will accept payments from the railroad equal to lost profits not to plant.

Question 45

Under a strict liability standard,the person who causes an accident is liable

A) whether or not he has been negligent.
B) if he could have prevented the accident at a cost less than the damages caused.
C) if he could have prevented the accident at a cost less than the damages caused times the probability of the accident's occurrence.
D) unless the plaintiff could have prevented the accident at a cost less than the damages incurred times the probability of the accident's occurrence.

Question 46

New England Company plans to build a power plant on the Charles River.By using river water to cool its plant,the river's water temperature will rise enough that trout will no longer survive,much to the dismay of local fishers.The loss of value to the fishers is estimated as $100,000.The transactions costs of a side payment from either side to the other are prohibitive of any agreement.Therefore,if the property right to the water is worth

A) more than $100,000 to New England Company,who gets the right would not matter.
B) more than $100,000 to New England Company,efficiency dictates giving the right to the fishers.
C) more that $100,000 to New England Company,efficiency dictates giving the right to New England Company.
D) less than $100,000 to New England Company,efficiency dictates giving the right to New England Company.

Question 47

In the Fable of the Bees,it was found that contrary to popular belief among economists,but consistent with the Coase Theorem

A) apple growers would pay bee keepers for pollination services.
B) bee keepers would pay orchard owners for access to their flowering trees.
C) apple growers and bee keepers would reimburse each other for increasing output.
D) the transactions costs of negotiating prevented any agreements from being reached between orchard owners and bee keepers.

Question 48

In the absence of transactions costs,a change in property rights will have no effect on economic efficiency.This result is known as

A) the Weak Coase Theorem.
B) the Strong Coase Theorem.
C) the Invisible Hand Theorem.
D) the Good Samaritan Theorem.

Question 49

Suppose transactions costs are created by a principal-agent problem.If the objective is economic efficiency,who should be made liable for damages resulting from the interaction of the principal and the agent?

A) The principal should be liable for all damages.
B) The agent should be liable for all damages.
C) Liability for damages should be equally split between the principal and the agent.
D) The assignment of liability is irrelevant according to the Coase Theorem.

Question 50

Incomplete property rights create transactions costs because

A) any party wanting to use the disputed resource does not have a fixed group with which to bargain.
B) the use of the disputed resource cannot be fully monitored by the government.
C) no one can prevent people from using the disputed resource for free.
D) others may receive a higher value from the disputed resource that those who own the property right to it.

Question 51

Montana cattle ranchers are complaining about mountain state sheep ranchers whose animals are eating too much grass on the open range.The sheep ranchers claim that the cattle are eating too much of the grass.This is an example of

A) an external benefit.
B) the reciprocal nature of externalities.
C) the principal agent problem.
D) a situation in which strict liability would be the more efficient solution.

Question 52

Prof.Epstein's normative theory of law argues that the common law ought to

A) promote a more desirable distribution of income.
B) impose punitive damages more often.
C) seek economic efficiency.
D) promote the Good Samaritan ethic.

Question 53

According to the Weak Coase Theorem,in the absence of transactions costs,the assignment of property rights has no effect on

A) damages paid by liable parties.
B) the distribution of income.
C) the allocation of resources.
D) economic efficiency.

Question 54

In the case before her,Judge Thomas has heard claims by orange growers that to order a stop to orange growing in order to control a pest that thrives on oranges plants but does not harm them would result in a loss of profits of $3 million a year.The pest however causes $2 million of damages to trees owned by pulp manufacturers.The orange growers have not mentioned that they could control the pest at a cost of $1 million per year.High transactions costs have prevented the parties from reaching a private agreement.If she gives the property right to the

A) orange growers,they will then voluntarily control the pest.
B) orange growers,they will not control the pest.
C) pulp manufacturers,they will pay the orange growers to control the pest.
D) pulp manufacturers,the orange growers would offer a side payment of at least $2 million to be able to grow oranges.

Question 55

A positive theory of common law,in which the positions of the courts are predicted based on the assumption that they are attempting to promote efficiency,is proposed by

A) Pigou.
B) Coase.
C) Posner.
D) Epstein.

Question 56

The Strong Coase Theroem states that in the absence of transaction costs,the assignment of property rights

A) has a negative effect on how resources are allocated.
B) has a positive effect on how resources are allocated.
C) has no effect on how resources are allocated.
D) does not affect the efficiency of how resources are allocated.

Question 57

Under a standard of contributory negligence,a plaintiff cannot collect for damages if his cost of preventing the accident is less than

A) the defendant's cost of preventing the accident.
B) the damages incurred from the accident.
C) the damages incurred times the probability of the accident's occurrence.
D) the punitive damages imposed by the court.

Question 58

If firms must pay full liability for accidents plus punitive damages,then

A) the private costs of firms' activities will be equal to the social costs.
B) firms will have an incentive to make efficient choices.
C) social welfare will be higher than if no punitive damages were assessed.
D) firms will undertake less activity than would be socially optimal.

Question 59

A neighbor slips on an icy sidewalk in front of your house,resulting in $500 of medical bills.The court rules that the accident had a 20% chance of occurring.Under a negligence standard,you will be held liable for damages if removing the ice from the sidewalk would have cost you less than

A) $20.
B) $100.
C) $500.
D) $1,000.

Question 60

An employer is liable for torts committed by his employees under the

A) principle of general average.
B) doctrine of respondeat superior.
C) Good Samaritan Rule.
D) contributory negligence standard.

Question 61

An employee injured by a damaged machine that the employer knows is broken has recourse under

A) the Good Samaritan Rule.
B) the standard of Strict Liability.
C) the legal principle of General Average.
D) the doctrine of Respondeat Superior.

Question 62

In the law of torts,what is meant by a negligence standard? How does a negligence standard promote economic efficiency? How can it lead to less-than-efficient outcomes?

Question 63

In a world without transactions costs,how will a change in property rights affect

Question 64

A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.



-Refer to A Negative Externality Problem.According to Pigou,the socially optimal level of production is

A) 0 units.
B) 30 units.
C) 40 units.
D) 45 units.

Question 65

Why does a principal-agent problem create transactions costs? If the goal is economic efficiency,what liability rule should be used when a principal-agent problem exists?

Question 66

Railway engines create sparks,which sometimes set fire to crops planted near the tracks.A large number of farmers are affected,and transactions costs prevent the farmers and the railroad from negotiating bribes or side payments.The price of railway service is $250 per train,and each train causes $50 of crop damage.The accompanying diagram shows the relevant market for railway service.

Question 67

The accompanying diagram shows the U.S.market for automobiles.P₀ is the world price of automobiles,Q₀ is the quantity of American automobiles produced,and Q₁ - Q₀ is the quantity of automobiles imported.Consumers are indifferent between American and imported automobiles,but each imported automobile creates $100 of pollution costs.

Question 68

A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.



-Refer to A Negative Externality Problem.Suppose there is no attempt to internalize the externality.Pigovian analysis indicates that the externality creates a deadweight loss equal to

A) $0
B) $25
C) $50
D) $100

Question 69

Explain how positive externalities cause a wedge between private marginal costs and social marginal costs.Give an example of a positive externality and explain why it is,in fact,a positive externality.Draw a supply/demand diagram and add a social marginal cost curve that represents the presence of the positive externality.Explain the relationship between the equilibrium quantity and that which is socially efficient.

Question 70

A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.



-Refer to A Negative Externality Problem.Suppose there are no transactions costs.Also suppose the externality is internalized when the damaged parties offer producers a bribe of $10 per unit to reduce their production.Coasian analysis indicates that social gain in this situation will equal

A) $0
B) $800
C) $1,600
D) $3,200

Question 71

Discuss the similarities and differences between "Cap and Trade" and a "Pigou Tax" as they apply to correcting for externalities.Focus on how each affects the price paid by consumers,the price received by producers,and the amount of revenue received by the government.Also discuss the potential problems with achieving the efficient outcome under each system.

Question 72

Cap and Trade is a system aimed at correcting for externalities by

A) imposing taxes.
B) establishing tradable permits.
C) placing quotas on specific firm's output.
D) limiting exports.

Question 73

A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.



-Refer to A Negative Externality Problem.The equation for social marginal cost is

A) MC_S = 10 + Q
B) MC_S = Q
C) MC_S = 20 + Q
D) MC_S = 10 + 10Q

Question 74

A Negative Externality Problem

Demand for a good is given by Q = 100 - P. The private marginal cost of production is MCP = 10 + Q. There is a $10 per unit negative production externality in this situation.



-Refer to A Negative Externality Problem.Absent any intervention,the competitive market will produce

A) 40 units.
B) 45 units.
C) 55 units.
D) 60 units

Question 75

How does a Pigou tax work? Why might a Pigou tax fail to achieve an efficient outcome?