Problem
I. Give an example of a negative externality and a positive externality. Explain why market outcomes are inefficient in the presence of externalities.
II. Give an example of a private solution to an externality. What is the Coase theorem? Why are private economic actors sometimes unable to solve the problems caused by an externality?
III. List some of the ways that the problems caused by externalities can be solved without government intervention.
IV. Imagine that you are a nonsmoker sharing a room with a smoker. According to the Coase theorem, what determines whether your roommate smokes in the room? Is this outcome efficient? How do you and your roommate reach this solution?
V. Even if the externality issue is resolved using a private solution (Coase), can you think of other issues or problems that would stem from the situation? (For example, how do you determine to whom to give rights?).