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10 Externalities CHECKPOINTS 2

Checkpoint 10.1 Checkpoint 10.2 Problem 1 Problem 1 Problem 2 In the news In the news

Practice Problem 1 CHECKPOINT 10.1 The figure shows the unregulated market for a pesticide. When factories produce pesticide, they create waste and dump it into a lake. The marginal social cost of producing the pesticide is double the marginal private cost. What is the quantity of pesticide produced if no one owns the lake? What is the efficient quantity of pesticide? 4

CHECKPOINT 10.1 Solution The quantity of pesticide produced is 30 tons a week. The efficient quantity of pesticide is 20 tons a week. 5

Practice Problem 2 CHECKPOINT 10.1 The figure shows the unregulated market for a pesticide. When factories produce pesticide, they create waste and dump it into a lake. The marginal external cost of the waste equals the marginal private cost of producing the pesticide. If the residents own the lake, what is the quantity of pesticide produced? How much do residents charge the factories to dump waste? 6

CHECKPOINT 10.1 Solution The quantity of pesticide produced is the efficient quantity, 20 tons a week. The townspeople charge the factories $50 a ton of pesticide, which is the marginal external cost of the pollution produced by 20 tons a week. 7

Practice Problem 3 CHECKPOINT 10.1 The figure shows the unregulated market for a pesticide. When factories produce pesticide, they create waste and dump it into a lake. The marginal external cost of the waste is equal to the marginal private cost of producing the pesticide. If the pesticide factories own the lake, how much pesticide is produced? 8

CHECKPOINT 10.1 Solution The factories produce the efficient quantity: 20 tons a week. 9

Practice Problem 4 CHECKPOINT 10.1 The figure shows the unregulated market for a pesticide. When factories produce pesticide, they create waste, which they dump into a lake. The marginal external cost of the waste is equal to the marginal private cost of producing the pesticide. If no one owns the lake and the government levies a pollution tax, what is the tax per ton of pesticide that achieves the efficient outcome? 10

CHECKPOINT 10.1 Solution The government can achieve an efficient outcome if it levies a pollution tax equal to the external cost because this tax confronts the factories with the social cost of pollution. A pollution tax of $50 a ton paid by the factories achieves the efficient quantity of pesticide. 11

CHECKPOINT 10.1 In the news New power-plant rule aids Northeast A new Obama air pollution rule requires coal-fired power plants to reduce both smog and acid-rain causing pollutants. The coal industry says this rule is among the most expensive ever imposed by the EPA. Source: The Wall Street Journal, July 7, 2011 Explain how a limit on pesticide will change the efficiency of the strawberry industry. Would a cap-and-trade scheme be more efficient? 12

CHECKPOINT 10.1 Solution To reduce the amount of pollution, power plants must produce less. The quantity of electricity decreases and the price that consumers pay for electricity rises. The outcome is efficient if the quantity of electricity produced is that at which the marginal social cost of electricity equals its marginal benefit. 13

Practice Problem 1 CHECKPOINT 10.2 The figure shows the marginal private benefit from college education. The marginal cost of a college education is a constant $6,000 a year. The marginal external benefit from a college education is $4,000 per student per year. What is the efficient number of students? If all colleges are private, how many people enrol? What is the tuition and the deadweight loss? 14

CHECKPOINT 10.2 Solution The efficient number of students is 50,000 a year—the intersection of the MSB and MC curves. Only 30,000 students a year— the intersection of the MB and MC curves —will enrol. Tuition is $6,000 a year. The area of the gray triangle equals the deadweight loss. 15

CHECKPOINT 10.2 Practice Problem 2 The figure shows the marginal private benefit from college education. The marginal cost of a college education is a constant $6,000 a year. The marginal external benefit is $4,000 per student per year. If the government decides to provide public colleges, what tuition will these colleges charge to achieve the efficient number of students? How much will taxpayers have to pay? 16

CHECKPOINT 10.2 Solution To enroll the efficient number of student (50,000 students), public colleges would charge $2,000 per student. Taxpayers would pay $4,000 per student. 17

Practice Problem 3 CHECKPOINT 10.2 The figure shows the marginal private benefit from college education. The marginal cost of a college education is a constant $6,000 a year. The marginal external benefit from a college education is $4,000 per student per year. If the government decides to subsidize private colleges, what subsidy will achieve the efficient number of college students? 18

CHECKPOINT 10.2 Solution The efficient number of students is 50,000 a year—the intersection of the MSB and MC curves. The subsidy would be $4,000 per student, which is equal to the marginal external benefit. 19

Practice Problem 4 CHECKPOINT 10.2 The figure shows the marginal private benefit from college education. The marginal cost of a college education is a constant $6,000 a year. The marginal external benefit from a college education is $4,000 per student per year. If the government offers vouchers to those who enroll at a college and no subsidy, what is the value of the voucher that will achieve the efficient number of students? 20

CHECKPOINT 10.2 Solution The efficient number of students is 50,000 a year—the intersection of the MSB and MC curves. Enrollment will be 50,000 if the tuition is $2,000. The private college tuition is $6,000, so to get 50,000 students to enrol, the value of the voucher will have to be $4,000. 21

CHECKPOINT 10.2 In the news Tuition hikes, not loan access, should frighten students Despite the hard times, families will not be deprived of access to federal student loans. The real danger is a hike in tuition. Often in past recessions, states have cut funding for colleges and tuition has skyrocketed. The Cato Institute says a better policy would be for the states to maintain the subsidies to colleges. Source: Michael Dannenberg, USA Today, October 22, 2008 (a) If government cuts the subsidy to colleges, why will tuition rise and the number of students enrolled decrease? 22

CHECKPOINT 10.2 (b) Why does the Cato Institute say that it’s a better policy for government to maintain the subsidy? Solution A cut in the subsidy will increase the college’s marginal cost. Tuition will rise and the number of students will decrease—a movement up along the demand curve. Because fewer than the efficient number of students will be educated, the Cato Institute says maintaining the subsidy is a better policy. 23