Questions:
Problem Set: Externalities
1. Identify each of the following as a positive or negative; production or consumption externality.
a. Christmas tree farms emit large quantities of oxygen that offsets the effects of CO2 in causing global warming.
b. Trucks that are jacked up on monster tires not only block the vision of other drivers, but are more damaging and unstable in an accident, leading to more likelihood of an accident and more severe injuries to people in both vehicles if an accident occurs.
c. Rene grows beautiful flowers in his front yard, to the great enjoyment of the neighborhood.
d. Pesticides used in agriculture can be washed into marshes where they reduce the fish populations.
2. Almond growers in CA are very concerned. Normally, honey producers would keep their bees next to almond orchards, where the bees would gather nectar and pollinate the almond trees. Lately however, bee keepers have moved to Arizona where it is cheaper to operate. Without the bees, the almond trees had very low yields, so the cost of production rose and profits were down considerably.
a. Describe the externality in this situation.
b. What possible solution is suggested by the Coase Theorem?
c. Is this solution likely or unlikely to work out in this case? Why or why not?
3. The most common technology used for dry cleaning clothing uses toxic substances that, if disposed of in drains, will contaminate the water supply and cause brain damage in some people. The cost to society of these health effects has been estimated to be about 35 cents per item of clothing cleaned this way. A clean technique has been invented, that adds 22 cents to the average cost of production. It has only been adopted by 2 firms. Assume that this is a competitive market.
a. Describe the externality in this situation.
b. What would be the most efficient technology to use (from the economic perspective)?
c. Explain why this market will NOT be allocatively efficient (why it will not produce the output with the most surplus).
d. Draw a graph showing the externality and the loss in the market.
e. Describe a policy that could be used in an attempt to internalize the externality.
f. Describe a second policy that might also be used and briefly compare the pros and cons of each policy (based on the reading.)
4. Many environmentalists, or general members of the public, are horrified by the notion of marketable pollution permits. They argue that big corporations should not be able to buy the right to pollute the environment. Make the counter-argument, from the economics point of view, as to why marketable permits (if done correctly) lead to the optimal outcome.