Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Stephen Buckles, Principles of Economics, Only One Edition needed

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N. Gregory Mankiw, Principles of Economics, 8th Edition

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Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

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Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

Explore this textbook

Read the fully unlocked textbook below, and if you’re interested in learning more, get in touch to see how you can use this textbook in your course today.

Chapter 13: The Economic Role of Government 1

Figure 13.1: The White House. [1]​
In 2000, the U.S. Congress passed legislation and appropriated $20 million to provide goat and sheep farmers a $.40 subsidy for each pound of mohair and wool they produced. ‘The Wool and Mohair Loss Assistance Program will help get this important industry back on its feet,’ said Representative Henry Bonilla of Texas. 


Public Interests; The Comeback Goats [1]

​"Representative Lamar Smith took extreme umbrage when people suggested that there was no point in subsidizing a product that nobody seemed to want. ‘Mohair is popular! I have a mohair sweater! It’s my favorite one!’" [...]

​"Last year Congress appropriated $20 million to provide goat and sheep farmers a $.40 subsidy for each pound of mohair and wool they produced. ‘The Wool and Mohair Loss Assistance Program will help get this important industry back on its feet,’ said Representative Henry Bonilla of Texas. "

                   -Gail Collins for The New York Times, March 13, 2001 

13.1 Objectives

After reading this chapter, answering the questions in the text, and doing the exercises, you will be able to:

  • Discuss economic policy in light of the goals of economic efficiency and equity.
  • Understand that goods and services that have external costs or external benefits may not be produced in private markets in an economically efficient manner.
  • Explain why private producers make some goods and services while local, state, and federal governments produce others.
​ Figure 13.2: These sheep are restricted from accessing the pastures around them, unlike those in the Tragedy of the Commons. [2]

Market economies direct resources to uses most valued by consumers. Our discussions of supply and demand have taught us by now that competitive market outcomes will be economically efficient in that the best allocation of resources will occur and allocation will be accomplished at the lowest possible cost. However, from time to time, there may be what economists describe as market failures.

Question 13.01

Question 13.01

Can you give some examples of situations in which markets may not be efficient?

Hover here to see the hint for Question 13.01.
Click here to see the answer to Question 13.01.

Market outcomes may fail to maximize total surplus for a number of reasons. We have already covered one example of inefficient markets in this book; monopolies do not work very well in responding to consumer demands and may not produce economically efficient amounts of output. Yet because of economies of scale, we may indeed want monopolies to exist to provide goods at the lowest possible costs. In Chapter 11: Between Competition and Monopoly, we explored the disadvantages of market concentration, and in Chapter 12: Regulation of Firms with Market Power we discussed the use of antitrust laws to prevent excessive market concentration, and the use of regulation when we do want monopolies to exist. This regulation is one example of an economic role of government. But there are other economic justifications for government intervention in an economy.

  • Some goods and services generate costs and benefits that are paid and received by people other than the producers and consumers. When that happens, the market outcome may not be economically efficient. A competitive market allocates resources so that the marginal cost to producers equals the marginal benefit to consumers of using resources. But if there are additional costs or benefits that the decision-makers – the buyers and sellers – do not consider when making decisions, the outcomes of private markets will not be efficient.
  • Given the very nature of other goods, it may be difficult for private businesses to ensure that consumers pay for the good and the business makes a profit. Thus, these goods will not be provided in private markets. In these cases, if the goods are to be produced, governments will have to provide them.
  • Consumers may not have complete information readily available about the content, quality, or safety of goods and services they purchase. Examples include prescription drugs, food products, and airlines. The efficiency of market outcomes can be enhanced if governments ensure the provision of additional information or institute requirements to provide safe products.
  • The macroeconomic role of fiscal and monetary policies in influencing price stability, unemployment, and sustainable economic growth is discussed in macroeconomic courses and will not be emphasized here.
  • Societies as a whole may deem the income distribution that results from a market system unfair or inequitable. When that happens, a variety of government programs and tax systems may be created to make the economy a fairer one. This topic is frequently covered in more advanced economics courses and is introduced in Chapter 15: Taxes of this book.

In this chapter, we will concentrate on the first, second, and third economic roles. We will begin with the role of government when we encounter goods and services that generate costs and benefits that accrue to individuals other than the buyers and sellers. From there we will discuss what happens if people don’t have to pay for a good or service to consume it.  And finally, we will examine the consequences of situations where potential buyers do not have complete information about specific goods and services.

13.2 External Costs and External Benefits

Figure 13.3: How many people will benefit from this young man’s shovelling prowess? [3]​

Goods sometimes have costs associated with production that are not borne by the producers themselves. And it is possible for consumption to have external costs as well. Examples of this could be:

  • A coal power plant
  • A run-down house in a neighborhood

Some goods have significant external benefits, meaning that when they are consumed, people other than the individuals who consume or produce the good benefit. In these cases, demand for goods does not reflect the entire benefit of the goods. Examples of this could be:

  • Elementary and secondary education
  • Academic and medical research
  • Shovelled sidewalks

13.2.1 External costs

Competitive markets produce quantities of goods and services that are economically efficient. Competition forces producers to use the lowest-priced inputs, use the best technology, and, in the long run, produce at the minimum possible average cost. Those markets are also allocatively efficient in that they produce where prices are equal to marginal costs. We are as well off as possible.

However, if there are additional costs or benefits not recognized by the producers or consumers, the competitive market outcomes may not be allocatively efficient.
To start thinking about these additional costs and benefits, first think back to Chapter 9: Competitive Markets and our discussion of supply curves.

Question 13.02

Supply curves in competitive markets represent which of the following?

A

Marginal costs of production

B

Average costs of production

C

Supplier fixed costs

D

Marginal benefits to consumers


Graphing Question 13.01

Suppose that each additional unit of output imposes a constant per unit cost on others. The function that represents the social costs for each additional unit of output is the marginal (private) cost (represented by the market supply curve) plus the external cost of each of those additional units of output. The marginal social cost curve is shown in Figure 13.4.

Figure 13.4: A market with external costs.

From the point of view of society, costs of a particular good or service include the private costs of producing the good or service, as depicted in the market supply curve, plus the external costs, or costs that are borne by others. Social costs are the total costs to society. Social costs equal the private costs plus the costs borne by people other than the consumers and producers.

Question 13.03

Question 13.03

For a product with external costs, the social cost curve lies above the market supply curve. Explain why that is the case.

Hover here to see the hint for Question 13.03.
Click here to see the answer to Question 13.03.

Question 13.04

Question 13.04

Given these supply and demand curves, along with the social cost curve, what quantity of output would the private market produce?

question description
A

Quantity A

B

Quantity B

C

Quantity C

D

Quantity D

Click here to see the answer to Question 13.04.

Question 13.05

Question 13.05

Given your answer to Question 13.04, what can you say about the social cost of production at that point, compared to the consumer’s marginal benefit? The social cost of production is ______________ than the consumer’s marginal benefit.

A

Higher

B

Lower

C

Equal to

D

Can’t tell

Click here to see the answer to Question 13.05.

Question 13.06

Question 13.06

Where should the market produce if it is allocatively efficient?

question description
A

Quantity A

B

Quantity B

C

Quantity C

D

Quantity D

Click here to see the answer to Question 13.06.

Graphing Question 13.02

A competitive market will produce where the supply curve faced by the firm and the market demand curve intersect. But from the point of view of society, or to evaluate whether that market outcome is an economically efficient one, we want to compare marginal social costs with marginal social benefits. In this case, the marginal social benefit is the same as the marginal private benefit, represented by the demand for the product. Thus, the competitive market produces too much of the good, and the equilibrium market price is too low. Production should be reduced until the marginal social cost is no longer greater than the marginal social benefit.

13.2.2 External Benefits

Consider a market with external benefits to consumption. Recall the outcome from a competitive market.

Question 13.07

Demand curves in competitive markets represent which of the following?

A

Marginal costs of production

B

Average costs of production

C

Supplier fixed costs

D

Marginal benefit to consumers

Now suppose there are external benefits to consumption that do not accrue to the consumers so that the private market demand curve does not represent all of the benefits received from the product. For example, a homeowner in a snowy climate might hire a service to clear snow from the sidewalk in front of their house. The benefits of the cleared sidewalk do not solely accrue to the homeowner, but also to anyone who might be passing by. In this case, the homeowner’s private benefits (represented by the demand curve) and external benefits (those received by others) equal the total amount of benefits from consuming the snow clearing service.

Graphing Question 13.03

Elementary and secondary education are also good examples of products with external benefits. Students benefit directly, and they and their parents make decisions based on those benefits – but others benefit also. An educated population is more productive, more likely to be employed, better able to support families, less likely to engage in illegal activities, and more likely to participate fully in our economic, social, and political societies. In general, for goods with external benefits, if the additional benefits that are received by others for each unit of production are added to the price each consumer is willing to pay, the result is the marginal social benefit (See Figure 13.5).

Figure 13.5: A competitive market with external benefits​​.

Question 13.08

Question 13.08

What quantity will the private market produce in this situation?

question description
A

Quantity A

B

Quantity B

C

Quantity C

D

Quantity D

Click here to see the answer to Question 13.08.

Question 13.09

Question 13.09

What is the efficient quantity of production in this situation?

question description
A

Quantity A

B

Quantity B

C

Quantity C

D

Quantity D

Click here to see the answer to Question 13.09.

Graphing Question 13.04


Firms will still produce the equilibrium market quantity, but now the economically efficient amount of production is greater than that amount. For both snow clearing and education goods, the market will under-produce relative to the efficient point.

Question 13.10

Question 13.10

Explain why the efficient amount of production in a competitive market with external benefits is greater than the equilibrium market quantity.

Hover here to see the hint for Question 13.10.
Click here to see the answer to Question 13.10.

13.3 Adjusting to External Benefits and External Costs

We have just seen that firms in competitive markets will not necessarily voluntarily produce the allocatively efficient amounts of output. It turns out that governments may be able to influence markets to make them more efficient.

Suppose that five suggestions were made to increase allocative efficiency in markets with external benefits or external costs.

1. A tax is placed on the producer
2. A subsidy is given to the producer. 
3. Government requires producers to produce more.
4. Government requires producers to produce less.
5. In the case of external benefits, the government produces the good.

Let's consider these suggestions in cases with external benefits and then with external costs.

13.3.1 Economic Efficiency and External Benefits

Question 13.11

What can you say about the equilibrium quantity of production and the equilibrium price for a market with external benefits?

A

The equilibrium market quantity is too high, and the equilibrium market price is too low, relative to the efficient level of production.

B

The equilibrium market quantity is too low, and the equilibrium market price is too high, relative to the efficient level of production.

C

The equilibrium market quantity is too low, and the equilibrium market price is too low, relative to the efficient level of production.

D

The equilibrium market quantity is too high, and the equilibrium market price is too high, relative to the efficient level of production.

Question 13.12

Question 13.12

What do you think of suggestions one and four in this case?

Hover here to see the hint for Question 13.12.
Click here to see the answer to Question 13.12.

Now consider options for dealing with external benefits wherein the government forces firms to produce more (option three above). If the government forced the firms to produce the economically efficient amount, it would mean that each competitive firm would be producing more than the amount where private marginal cost and marginal revenue are equal. Thus, they would not be maximizing profits. Because competitive firms earn zero economic profits in the long run, firms would now earn economic losses and eventually leave the industry. For this reason, forcing firms to produce more would be an ineffective tool in competitive industries.

A subsidy given to the producer (suggestion two) will have an interesting effect. In effect, a subsidy changes the costs of production to producers; a $1 subsidy reduces the costs producers incur in production.

Question 13.13

Question 13.13

What will the equilibrium market quantity be if the government provides subsidies directly to the producer? Assume the subsidy is a fixed amount for each good produced and exactly equal to the size of the marginal social benefit for each unit produced.

question description
A

Quantity A

B

Quantity B

C

Quantity C

D

Quantity D

Click here to see the answer to Question 13.13.

The firms would find that at their original equilibrium quantities, the new marginal cost (the original private marginal cost minus the subsidy) would be below the price and thus expand. They would expand up to that point where the new marginal costs (represented by the new supply) were just equal to the market price. If the subsidy is the correct amount, the market outcome will be equal to the efficient level of output. The new equilibrium, where the supply curve (with the subsidy) intersects the private demand curve, is also the efficient outcome.

So, one possible solution to the external benefits problem is a subsidy to producers. Governments could also use this model as a guide for determining the economically efficient amount of production and either produce the additional amount necessary or produce the entire amount. (This is option five above.)

Question 13.14

If the government produces the entire amount, what price should the government charge?

question description
A

P1

B

P2

C

P3

D

P4

Question 13.15

Question 13.15

At the price from the previous question, what quantity might private (non-government) suppliers produce?

question description
A

Q1

B

Q2

C

Q3

D

Q4

Question 13.16

Question 13.16

Using concepts from the first part of this chapter, why might some cities buy trees and give them to residents to plant?

Hover here to see the hint for Question 13.16.
Click here to see the answer to Question 13.16.

13.3.2 Economic Efficiency and External Costs

Now consider the case of external costs, where there are social costs in addition to private costs of production. The market, of course, will produce where the quantity supplied equals the quantity demanded. However, at that point, the marginal social cost is greater that the marginal private benefit.

Question 13.17

What can you say about the equilibrium quantity of production for a market with external costs?

A

The equilibrium market quantity is too high and the equilibrium market price is too low, relative to the efficient point.

B

The equilibrium market quantity is too low and the equilibrium market price is too high, relative to the efficient point.

C

The equilibrium market quantity is too low and the equilibrium market price is too low, relative to the efficient point.

D

The equilibrium market quantity is too high and the equilibrium market price is too high, relative to the efficient point.

Too much is being produced from the point of view of economic efficiency.

Question 13.18

Question 13.18

Of the available options for government action above, which are most likely to be successful in addressing the problem of external costs?

Hover here to see the hint for Question 13.18.
Click here to see the answer to Question 13.18.

Let’s consider what happens under a tax on producers. Recall that supply curves represent marginal private costs and suppose that the government implements a tax on every unit of output produced.

Graphing Question 13.05

Question 13.19

What can you say about the allocatively efficient level of output compared to the new equilibrium market quantity after the tax on producers described above is imposed?

A

They are the same.

B

The equilibrium market quantity is greater.

C

The allocatively efficient quantity is greater.

D

You cannot tell from the information given.

Figure 13.6 demonstrates a market with external costs and the resulting marginal social cost curve.

Figure 13.6: A market with external costs.​

A tax equal to the amount of external cost will shift the private supply curve back to equal the marginal social cost curve (See Figure 13.7).

Figure 13.7: Efficient quantities and prices in a market with external costs and taxes.​​​

An alternative to imposing taxes would be to simply require the firms to reduce production.

Question 13.20

Question 13.20

In addition to taxes, what other regulation could the government impose that would achieve the efficient outcome?

Hover here to see the hint for Question 13.20.
Click here to see the answer to Question 13.20.

The allocatively efficient amount of output for a good with external costs would be equal to the level of output where marginal social cost equals marginal social benefit (same as marginal private benefit in this example), which is less than the equilibrium market quantity. If such reduction in output were achieved through a regulation requiring a reduction in each firm's output, each firm would be producing where marginal revenue is greater than marginal cost and average cost is above the minimum. Existing firms would want to expand and other firms would want to enter.

Because of the challenges in enforcing limits on production of goods with external costs, the more common type of effort is a requirement for firms to reduce external costs directly by putting caps on pollution or establishing a tax on pollution. In some parts of the country, a limited number of pollution permits are issued and then sold in a market.

13.4 Reducing Pollution

One of the most common sources of external costs is pollution. In the process of consuming electricity, private individuals and firms in the United States produce tons of nitrogen oxide and other pollutants. These pollutants, in turn, contribute to smog levels and acid rain, generating external costs to individuals who didn’t produce or consume the electricity in question.

Suppose the costs of reducing some amount of nitrogen oxide for three individual firms are as shown in Table 13.1. (The costs are hypothetical to make the example simpler and more straightforward.) The costs of reducing the pollution are the costs of the scrubbers and alternative fuels necessary to produce electricity with less nitrogen oxide as a byproduct.




















Table 13.1: Firm costs of pollution reduction. ​

Suppose that the three firms in Table 13.1 are the only ones in the economy.

Graphing Question 13.06

Question 13.21

Question 13.21

Describe the nature of the costs of the pollution reduction in Table 13.1 and in your answer to Graphing Question 13.06. Why might the marginal costs be behaving as they are?

Hover here to see the hint for Question 13.21.
Click here to see the answer to Question 13.21.

A calculation of marginal costs shows that the marginal costs increase as more pollution is eliminated. In most production processes, elimination of some pollution can be accomplished by relatively simple changes in production processes. Thus, the cost of the initial reductions may be relatively small. It makes sense for a firm that is going to reduce pollution to reduce pollution with the least expensive methods first. However, as more and more pollution is eliminated, the costs of doing so increase. Firms may need to purchase expensive equipment to control their emissions, or they might need to make arrangements to secure alternative sources of electricity such as solar panels.

Given these costs of pollution reduction, governments seeking to maximize efficiency will compare the costs of reducing pollution to the benefits of the same. Our understanding of the benefits of pollution reduction is increasing, and scientists are measuring the health and environmental impacts of pollution in the United States with increasing precision.

Question 13.22
question description

Suppose that Table 13.1 represents the pollution of three firms in your hometown and that the Environmental Protection Agency establishes that the benefits of reducing pollution in your hometown are $21/ton. What is the optimal level of pollution for the firms in this local economy?

A

50,000 tons

B

75,000 tons

C

100,000 tons

D

150,000 tons

Optimal pollution decisions should be made through a comparison of the marginal costs and marginal benefits of reducing pollution. At the current levels (225,000 tons), for example, the cost of pollution reduction is less than the benefit ($21/ ton) for the first 75,000 of those tons. So, the efficient outcome is to reduce pollution to 150,000 tons.

Can any amount of pollution be optimal? Note that the optimal amount of pollution in the previous example is not zero. Why is that statement likely to bother some people? And why should it not bother you as a microeconomics student?

Question 13.23

Question 13.23

How can pollution be good? Or is that really what we mean?

Hover here to see the hint for Question 13.23.
Click here to see the answer to Question 13.23.

Question 13.24

Question 13.24

Using the concepts we used to determine that "optimal amount," describe the conditions under which no pollution should be allowed. In other words, when does it make sense to have zero pollution?

Hover here to see the hint for Question 13.24.
Click here to see the answer to Question 13.24.

13.4.1 Achieving Pollution Reduction 

A variety of means of achieving reduced pollution levels are available to governments. The most common method has been regulation requiring firms to reduce pollution by specified amounts. A second alternative has been to use taxes to affect the production of pollutants.

A third option involves creating property rights in pollution. The 1990 Clean Air Act created markets for pollution permits. Those markets allow the purchase and selling of permits, each one of which gives the owner the right to emit a specified amount of pollution. While these have been controversial, active markets are functioning and these markets have become a significant aspect of national and worldwide pollution reduction efforts.

Let’s look at three methods: regulation, taxes on pollution itself, and markets for permits to pollute. Refer again to the information in Table 13.1, and assume that we have already determined that the economically efficient amount of pollution is 150,000 tons.

Question 13.25

Question 13.25

Given the pollution of Firms A, B, and C, what are the available options if the goal is to reduce total pollution to 150,000 tons?

Hover here to see the hint for Question 13.25.
Click here to see the answer to Question 13.25.

Question 13.26
question description

What would be the cost of a regulation that all firms reduce their pollution by one-third?

A

$1.0 million

B

$1.6 million

C

$4.2 million

D

$6.0 million


Question 13.27
question description

Which of the following taxes, imposed on polluters on the basis of how many tons of pollution they emit, would result in exactly 150,000 tons of pollution?

A

$5/ton

B

$18/ton

C

$21/ton

D

$121/ton


Question 13.28
question description

What would be the cost of the pollution reduction if all firms were subject to the tax from Question 13.27?

A

$1.0 million

B

$1.6 million

C

$4.2 million

D

$6.0 million


Question 13.29
question description

What would be the cost of the pollution reduction if all firms were allowed to pollute as long as they had a legal permit? Assume that permits allowing a total of 150,000 tons were issued by the government and auctioned off to these firms.

A

$1.0 million

B

$1.6 million

C

$4.2 million

D

$6.0 million

These different options are summarized in this video about chicken production:

The video above demonstrates, in a somewhat simplistic way, the options available to governments for reducing pollution: carbon taxes, permits, and direct regulation.

13.4.2 Choice of a System

Economists will favor a tax or permit system over a regulation system because the same reduction in pollution can be achieved at the lowest possible costs. Taxes and permits will result in the same cost to the firms. With a tax system, the taxing authority has to determine the right amount to tax. With a permit system, the businesses themselves determine the amount of the tax, and thus the permit system may be less expensive to administer.

If devices for measuring the output of pollution are too expensive, then direct controls may make sense. And if the allocatively efficient amount of pollution is zero because of the extreme costs of a particular type of pollution, then regulation may be the only rational way.

Question 13.30

Question 13.30

In Nashville, Tennessee it costs $68 per ton of trash if that trash is taken to the thermal energy plant and burned. It costs $31 per ton of trash to ship it to a nearby landfill and to dump it. Does it make sense to take any trash to the thermal energy plant?

Hover here to see the hint for Question 13.30.
Click here to see the answer to Question 13.30.

Question 13.31

In efforts to increase economic efficiency, governments should ______________ goods with external costs.

A

Tax

B

Subsidize

C

Do nothing for


Question 13.32

In efforts to increase economic efficiency, governments should ______________ goods with external benefits.

A

Tax

B

Subsidize

C

Do nothing for


Question 13.33

The economically efficient amount of pollution will be zero when which of the following is true?

A

When costs of pollution are greater than the marginal costs of pollution reduction at all levels of pollution.

B

When costs of pollution are less than the marginal costs of pollution reduction at all levels of pollution.

C

Under no circumstances. Some pollution is always economically efficient.

D

Under all circumstances. It is never economically efficient to have consumers or producers force others to pay the costs of pollution.


Question 13.34

Once a government has introduced a proper (that is, economically efficient) policy to address the market failure, the price of a good that has external benefits will be ______________ than its free market price and the price of a good that has external costs will be ______________than its free market price.

A

Higher; lower

B

Higher; higher

C

Lower; lower

D

Lower; higher

13.5 Private Goods, Public Goods, and Common Resources

Figure 13.8: This uncrowded park is a public good. [4]​

Most goods and services produced in markets can be described as private goods:

a. The good or service cannot be consumed by more than one person at a time.
b. Producers are able to exclude non-buyers from consuming the good or service. – from automobiles to houses to clothing to breakfast cereals. The very nature of other goods and services creates real problems for private markets. It may be impossible or quite costly to exclude nonpaying consumers. In those cases, it is difficult for private firms to produce the goods, charge a price, pay the costs of producing the goods, and earn a profit. If a firm cannot prevent nonpaying customers from using a good, it will be challenging to convince other people that they should pay for the service. 

Question 13.35

Question 13.35

Can you think of examples of goods where excluding non-payers is difficult?

Hover here to see the hint for Question 13.35.
Click here to see the answer to Question 13.35.

Examples of goods and services where it is difficult to prevent nonpaying customers from consuming:

  • Local broadcast television and radio programs
  • Street lighting
  • A fourth of July fireworks celebration
  • Public street

Another defining characteristic of some non-private goods is whether they can be shared without reducing their value. Private goods are of the type that if you consume it, I cannot. And if I consume it, you cannot. Think of an apple. If you eat the apple, your roommate cannot. It is gone.

However, there are other goods you can consume for which your consumption does not interfere with your roommate's consumption of the same good. Think of a sunset. Or an uncrowded hiking trail. Or a road. You both can consume and enjoy the same good or activity at the same time. What a unique idea!

Question 13.36

Question 13.36

Can you think of other examples of goods with this quality? You might have some of the same goods on this list as you did in the previous question.

Hover here to see the hint for Question 13.36.
Click here to see the answer to Question 13.36.

Examples of goods and services that can be consumed by more than one individual at a time:

  • A fourth of July fireworks celebration
  • National defense
  • A city lake (at least, an uncrowded one)
  • Basic medical research
  • Lighthouses

There are still other goods, particularly natural resources, where non-payers cannot be prevented from the using the good, but where only one person or producer can consume the good. In other words, if one specific consumer does not use the resource, it will be gone because others will consume the good. These are most often resources for which there is simply no single owner.

Question 13.37

Question 13.37

Can you think of examples?

Hover here to see the hint for Question 13.37.
Click here to see the answer to Question 13.37.

Examples of goods and services where it is difficult to prevent consumption and where one person’s use may eventually exhaust the resource and prevent further production and consumption: 

  • Fish in oceans
  • Public grazing lands
  • Pools of underground oil

In each of the sets of examples above, private markets are likely to fail, and there may be an economic role for government. In these three instances, the goods will not be produced in an economically efficient manner. It is likely that in all three cases, the resources will fail.  In the third, it is likely that the resources will be consumed as quickly as possible and perhaps exhausted. In all three cases, competitive markets will fail to produce an economically efficient outcome.

13.5.1 Public Goods

Some goods and services have characteristics that make it difficult for them to be produced in economically efficient amounts by private markets. For example, if it is impossible or difficult to exclude individuals from consuming a good once it is produced – that is, if a firm cannot prevent a nonpaying customer from enjoying the goods – it is very difficult for a private business to produce the good and make a profit. Would you buy a good if you could easily consume it without paying? 

National defense is a good example. If you are protected from attack from an aggressor, it is most likely true that I am as well. It is difficult to exclude one individual from consuming the benefits of national defense once it is produced for others. If a business were to produce missiles, submarines, and planes and hire armies and sell all as a national protection service, many would be unwilling to pay for it - knowing that if it is provided, they will be able to enjoy the benefits, whether they pay for it or not. These individuals are often referred to as “free riders,” and their presence would make it hard for firms to make money in the national defense industry.

Individuals do voluntarily pay for some goods. Would you make a contribution to a business if it would provide national defense, police protection, or fire protection?

Would you do the same for basic medical research that may at some time in the future result in significant advances? Or to support your local public radio station? The answer may be yes in some cases; after all, charities do exist and ask individuals for voluntary donations. But any individual who chooses to pay for these goods is, in essence, voluntarily purchasing what they could have consumed for free.

National defense also carries another characteristic: one person’s consumption of it does not reduce another person’s ability to consume it. In fact, once national security has been provided, a country’s entire population can use it without diminishing its value.

Goods with both of these characteristics are known as public goods. A public good is exactly the opposite of a private good. Private goods and services are goods and services that cannot be consumed by more than one person at a time. In addition, producers are able to exclude nonpaying users from consuming the goods and services.

Preventing Armageddon: The Economic Hurdles of Asteroid Defense

Question 13.38

Question 13.38

Explain why it is difficult for governments to solve the asteroid defense problem.

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Click here to see the answer to Question 13.38.

Another common, though not universal, feature of public goods is that the marginal cost of providing one more unit or having one more consumer of the good may be zero. National defense, fire protection, police protection, lighthouses, and basic research are all goods where adding one more consumer adds nothing to cost. The marginal cost is zero. You can consume the good. If I can also consume the same good or service, there is not an additional cost to providing the good to me.

Question 13.39

Question 13.39

If the marginal cost is zero, how much of a good should be produced? Or how many customers should be allowed or encouraged to consume the good? Why?

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It may make sense from an economic efficiency point of view to provide these goods for free. That is, at a zero price. If our goal is economic efficiency and the marginal cost is zero, as much of the good that is demanded at a price of zero should be produced. If less than that is produced, the marginal benefit is greater than the marginal cost to society and we will be better off if we increase production and consumption.

Again, it seems clear that if public goods are to be produced, most will have to be produced or purchased by governments. Private producers will not be able to do so or at least not be able to produce enough to achieve an economically efficient level of production.

In practice, governments provide most public goods, but other solutions are possible. Private firms can produce the goods and be paid by governments. In other cases, charitable organizations produce the goods, with subsidies in the form of tax reductions for individuals who donate money. An example of the latter is the Sierra Club, an American environmental preservation organization that frequently seeks to preserve national forests and other federal lands. The club is funded by private individuals, foundations, and corporations and, except for its tax-exempt status, operates without funding from the U.S. government.

Some people may actually pay for public goods, but not all who benefit do. The result might look like the one shown in Figure 13.9. A few individuals may be willing to buy the good, but at that amount (100,000 in Figure 13.9), the additional benefits are far above the marginal costs. If only a few pay, too little is produced for allocative efficiency. Certainly, in the case that none of the good is produced, the marginal benefits of production are much higher than the marginal costs. The good should not only be produced but also be produced in an amount that results in the marginal benefits and marginal costs being equal. That is the amount that would be produced in a well-functioning private good market.

Figure 13.9: Market prices and quantities if 100,000 units are sold​.

Graphing Question 13.07

Question 13.40

Question 13.40

Why are broadcast radio stations like public goods? How are private producers able to provide the stations and earn profits?

Hover here to see the hint for Question 13.40.
Click here to see the answer to Question 13.40. 

13.5.2 The Tragedy of the Commons

Think of two eight-year olds drinking cold soft drinks. If they drink the soft drinks too quickly, they will have stomachaches and very cold throats. Compare two possible scenarios; the first scenario is that each eight-year-old has a cold soft drink in a glass with one straw. The alternative scenario is that there is one cold bottle and two straws in the bottle. The bottle holds twice as much, but the two eight-year-olds must share. What is likely to happen in each scenario? Which scenario has the better outcome?

You probably concluded that, if each has his or her own glass, they will be more likely to drink at a measured pace (one hopes). They know there is a cost to drinking too quickly. If they are drinking from a common bottle, incentives exist to drink more quickly than they normally would. Obviously, if one does not, that eight-year-old may not get his share. Both may end up with stomachaches.

Suppose Atlantic salmon swim along the coast of Maine each year. The northeastern fishing fleet goes into the ocean at just the right time of year to catch and harvest the salmon. If the fleet catches 1,000 tons of salmon, there will be just enough left this fall to breed and replenish the salmon caught this year. However, if more than 1,000 tons are caught, the school will begin to diminish in size until it cannot sustain itself. Salmon will likely disappear from the Atlantic. Salmon are described as common goods or common resources.

Question 13.41

Question 13.41

Given these facts, what do you think is likely to happen to Atlantic salmon off the coast of Maine if there are no regulations on fishing?

Hover here to see the hint for Question 13.41.
Click here to see the answer to Question 13.41. 

If no price is paid for a resource, competing firms will exhaust the resource and use more inputs while doing it. A single firm managing the resource is likely to be concerned with its future because it owns the rights to harvest or mine the resource in the future. However, if there are a number of firms using the same resource, some firms will be concerned that others will take from the resource and if the concerned firm does not take as much as it can now, it will be left out later.

A company that owns or manages a fishpond will pay the cost of taking a fish from that pond. That fish will not be available to catch in the future or to breed and produce more fish. Thus, the marginal cost of that fish is positive. If, however, the company does not own the pond, taking one more fish has close to zero marginal cost. Thus, the firm will expand its catch until the marginal revenue and marginal cost are equal.

Question 13.42

Question 13.42

Fishing, as an industry, is in trouble around the world due to declining fish populations. Some countries are subsidizing their fishing industries in order to assist them. What do you think of that as a policy to aid fishermen?

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Think of another "common" example - A pool of oil under the ground owned by ten different individuals. If oil is withdrawn at a steady slow pace, more will be able to be recovered. And the cost of a single oil well might be $1 million. However, if each owner drills her own well and withdraws oil as rapidly as possible, less total oil will be recovered, and the cost will be ten oil wells or $10 million. Clearly, if the landowners could cooperate, more oil would be recovered at a lower cost --- a more efficient outcome by any measure. Notice the difference here relative to national defense (or some other public good).

The original tragedy of the commons story was about a common pasture, as indicated by this video:

Property that is commonly owned or owned by no single individual may be overused or quickly exhausted. The solution is common ownership, charging a price, or regulating the rate of consumption. Alternatively, if the participants are from different countries, a treaty that forces participants to agree upon the rate at which they harvest the natural resource would make the efficient outcome possible. Finally, if it is possible to change the nature of the resource so that it becomes a private resource with a single owner or a coordinated group of owners, again the efficient outcome might be possible.

Governments often help facilitate solutions to the tragedy of the commons problem. In the case of fishing or hunting, government agencies sell permits or set quotas to regulate the amount of fishing or hunting performed in a given area over a specific time period. In other circumstances, governments might grant property rights in a way that increases the marginal cost of using a natural resource.

A final category of goods and services includes those where one person’s use does not impede another person’s use, but where individuals can be excluded from using the good or service. These are natural monopolies, and they are covered in Chapter 10: Monopoly.

13.6 Mohair and Other Farm Subsidies

This chapter began with a brief excerpt from an article discussing government subsidies provided to growers of mohair. One of a variety of farm product subsidies, the primary purpose (at least the stated purpose) is to assist farmers in a very risky business, provide a stable agricultural industry, and perhaps preserve farming as a way of life.

A variety of subsidies exist. Ninety percent of the subsidies go to wheat, corn, soybeans, rice, and cotton. Dairy products and sugar also receive significant subsidies. A common type of subsidy is one that guarantees farmers a minimum price for their products. If the market price falls below that price, the federal subsidy will make up the difference (times the amount produced) through payments to the farmers. Other programs give direct grants to farmers.

Question 13.43

Question 13.43

Make economic arguments in favor of government subsidies for farm products. Use the economic concepts we have discussed in this chapter.

Hover here to see the hint for Question 13.43.
Click here to see the answer to Question 13.43. 

​The challenge here is to identify a market failure. If there is a legitimate economic role for government, it has to be because of external costs or benefits, a market with the characteristics of public goods markets, a common good market, a not-very-competitive market, lack of information and concerns with safety for consumers, or simply a goal of changing the income distribution that results from an otherwise normal market.

In this case, the most often stated goals are to help the small farmer – perhaps an effort to redistribute income – and to preserve farming and rural communities as a way of life – perhaps an external benefit of farming. In reality, the programs stem from a dramatic shift in our economy away from agriculture to manufacturing and services. In that shift, millions lost jobs and livelihoods as they were forced to move to cities and new jobs. The subsidy programs are largely a result of the old effort to help make the transition easier. (In fact, the original motivation for farm subsidies was to provide income during the Great Depression.) And they still exist, in part because subsidy recipients are highly motivated to keep them in place and can afford to pay lobbyists and other influencers to make their case to lawmakers.

13.7 Government’s Role in Filling Information Gaps

The U.S. government has regulations on food quality. Meat is inspected and has to satisfy standards before it can legally be sold. Packaged foods are required to list contents and quantities of salt, sugar, fats, cholesterol, and protein and percentages of minimum daily nutritional requirements. Automobiles must meet given safety standards. Airlines are required to maintain aircraft in a manner that comes close to guaranteeing safe flying. Prescription and nonprescription drugs are subject to extensive testing before they are allowed on the market.

Question 13.44

What will happen in a competitive market if consumers are unable to estimate accurately the marginal utilities of goods?

A

There will be no change relative to a market where consumers know marginal utilities.

B

Consumers may over-estimate benefits and consume too much of a good.

C

Consumers may under-estimate benefits and consume too little of a good.

D

Both b and c are possible.

E

All three outcomes (a, b, and c) are possible.

Question 13.45

Question 13.45

Given your answer to the previous question, use our model of allocative efficiency to justify regulations that increase information for consumers.

Hover here to see the hint for Question 13.45.
Click here to see the answer to Question 13.45. 

If consumers cannot fully determine the quality or safety of a product, it will be difficult to  estimate marginal utility accurately. If consumers consistently overestimate the quality, then a competitive market will result in too much production. If consumers consistently underestimate quality, not enough of the good will be produced.

There is an economic role for government in establishing guidelines for some products to increase the availability of information and thus enhance economic efficiency. At the same time, many instances of incomplete information for consumers have been resolved through private markets. Examples include Amazon and other online shopping reviews, Angie’s List, online physician and realtor reviews, etc.

13.8 Government Failures

Figure 13.10: Photograph of the Department of Motor Vehicles in San Francisco [5]

Just as markets work to increase economic efficiency in many situations and fail in special circumstances, governments can enhance efficiency when markets fail, but they may themselves fail to contribute to efficiency in all situations. There are a number of reasons why.

13.8.1 Difficulty in Gathering and Interpreting Data

When information is difficult to obtain or not available, we may not get good data. In private markets, the costs and even benefits of goods, services, and resources are relatively easy for individuals and businesses to determine so that they can make decisions accordingly. However, when it comes to an economic role for government, the existence of external costs or benefits create unique measurement challenges. If it is not even clear who bears or receives the costs or benefits, it becomes particularly difficult to measure them. If the costs and benefits are received by different people in vastly different parts of the country, it is difficult to measure and compare. In those cases, it may not be possible to compare marginal benefits and marginal costs and make efficient decisions.

For example, consider a proposed interstate bypass to circumvent a small city. This road is a public good: one person’s use will not impede another person’s use, and travelers cannot be prohibited from using it. Should the government build such a road? The costs of construction might be straightforward to measure. But how would you measure the benefits? Beneficiaries are spread around the country, and there are no particularly good data that would give you a good measure of consumer benefits.

13.8.2 Conflicting Goals

Solutions to market inefficiencies are sometimes politically unpopular. For example, taxes that would serve to reduce consumption with external costs may not be politically feasible. And sometimes certain types of taxes become infeasible. If so, there may be a tendency to back away from more efficient taxes and lean toward those that are less efficient and viewed as fairer. This is particularly true if voters do not understand the inefficiencies created by a specific tax in the first place. So even if we have accurate data, we may not be sensitive to the data as other (political) goals become more important.

As an example, suppose the government concludes that construction of the bypass discussed above is efficient, i.e., that the benefits outweigh the costs. The most efficient tax for funding the road construction might be a gasoline tax. But local citizens are furious about paying a new tax at the pump when gas prices are already “too high” in their opinion. They might be willing to stomach other sorts of taxes, even if those are more distortive of behavior.

13.8.3 Incentives Are Sometimes All Wrong

People respond to incentives in their roles as consumers and producers. We see evidence of that every day. And it makes sense from an individual point of view. In fact, it even makes sense from society’s point of view in many cases. But when those incentives do not direct efforts toward efficient outcomes, an economic role for government can end up failing to improve on a market outcome and perhaps even making it worse. 

In many instances where there are clearly identifiable economic roles for governments, the benefits of a government policy or production are large but received by many individuals or businesses. If the overall benefits of a program are received by many, and the costs are paid by a few, it may be that the few have incentives to lobby and push against the program. The many, whom each receive small benefits, do not each have the incentive to argue in favor of the programs. An example is cigarette taxes. Cigarettes have substantial external costs from second hand smoke and healthcare costs. But the effects of cigarette taxes on cigarette manufacturers mean that they will lobby hard against any increase in taxes, even if those taxes are efficient from a social perspective.

It may be easier to add programs than to eliminate programs. If the costs of programs are not well identified, the benefits are often easier to see by the groups receiving those benefits. So if a program is considered for elimination, those who will lose the benefits will lobby against the elimination the most strongly. And those who will benefit from a new program will likely speak more loudly than those who will have to pay the bill, as they may not even recognize that they are paying the bill. A commonly invoked example is the U.S. sugar tariff, a tax on foreign-produced sugar which was first instituted in 1789. The tariff helps keep sugar prices in the U.S. high, a big benefit for U.S.-based sugar producers who lobby for its continuance. Of course, the tariff represents a substantial cost to U.S. sugar consumers. 

13.8.4 Incentives Are Sometimes Weak

Many if not most businesses want to produce quality products at the lowest possible costs. However, in competitive markets, they are forced to do so whether they want to produce those products or not. Actual or potential competitors force firms in competitive industries to produce what consumers want the most and at the lowest possible cost. 

That competition does not normally exist for government providers of goods and services. Promotion and salary increases are often granted to those with large staffs and growing programs and not necessarily to those with small, effective programs – the costs of which are being reduced. 

Our politicians face elections on a regular basis. If the types of decisions that are most likely to lead to reelection are not those with hard choices such as increasing taxes or cutting existing programs in order to pay for new programs, then reelection-seeking politicians may not make those rational, efficiency-enhancing choices. At least, the incentives to do so may not be very strong.

In some instances, programs that have benefits far in the future may be preferable to programs with short-term, smaller benefits. But if reelection is soon, it may be the programs with easy-to-see benefits that get approval. Efficiency is lost as a result.

Question 13.46

Question 13.46

In your own words, explain the economic role of government in a market economy.

Hover here to see the hint for Question 13.46.
Click here to see the answer to Question 13.46. 

Question 13.47

Question 13.47

What is the answer to the concerns of Representatives Bonilla and Smith as expressed in the quote at the beginning of the chapter? Should the U.S. government subsidize mohair production? Are there externalities? Is mohair a public good? A common resource?

Hover here to see the hint for Question 13.47.
Click here to see the answer to Question 13.47. 

13.9 Summary

  • Even seemingly competitive markets can fail to produce the efficient amount of output.
  • The existence of external costs or external benefits means that a market will produce either too much or too little of the good or service for economic efficiency.
  • If the good or service is a public good or service, it will fail to be produced in sufficient numbers by a competitive market.
  • If the good is a common one, it may be exhausted quickly. 
  • In each instance, a government may improve the economic efficiency of market outcomes through production, regulation, subsidies, or taxes. 
  • An efficient amount of a public good or pollution can be determined by comparing costs and benefits of the good or the costs of the pollution with the costs of reducing pollution. 
  • Regulation, taxes, and tradable permits are all methods for reducing pollution with differences in costs and benefits of each method.
  • Government failures occur due to the challenges of accurate measurement of costs and benefits, lack of competition with public production of goods and services, the distribution of benefits and costs, and the lack of effective incentives for government regulation and production.
Question 13.48

How would you classify television broadcasts?

A

Private goods

B

Public goods

C

Ones with external benefits

D

Common resources


Question 13.49

In efforts to increase economic efficiency, governments should ______________ public goods.

A

Tax

B

Subsidize

C

Do nothing for


Question 13.50

In efforts to increase economic efficiency, governments should ______________ common resources.

A

Tax

B

Subsidize

C

Do nothing for


Question 13.51

Common resources are used too ______________ for economic efficiency because the marginal cost of using the resource is ______________ than if the resources were private goods.

A

Slowly; lower

B

Quickly; lower

C

Slowly; higher

D

Quickly; higher

13.10 Key Concepts

  • Externalities
  • External costs
  • External benefits
  • Efficient amount of pollution 
  • Regulations, taxes, and tradable permits
  • Public goods
  • Free riders
  • The problem of the commons 
  • Government failures

13.11 Glossary

Common resource: A resource that can be consumed by only one producer or consumer at a time and is found in environments in which it is difficult to exclude nonpaying users.

External benefit: The benefits received by individuals other than the producer or consumer.

External cost: The costs of producing a good or service that are borne by individuals other than the producer or consumer.

Marginal social benefit: The marginal benefit of consumption from society's point of view.

Marginal social cost: The marginal cost of production from society's point of view.

Market failure: A condition wherein private markets do not produce an economically efficient allocation of resources.

Private good: A good and service that can be consumed by only one person at a time. It is also possible to exclude non-buyers from consuming the goods.

Public good: A public good has two characteristics. First, it is difficult or impossible to exclude non-buyers from consuming the good. Second, consumers can consume a public good without interfering with others' consumption of the same good.

Social benefit: External benefits plus private benefits.

Social cost: External costs plus private costs.





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Answer Keys

Answer to Question 13.01

One answer, based on Chapter 10, is a market with a monopoly supplier. You saw there that monopolists choose to sell a lower quantity than the allocatively efficient quantity. This chapter will highlight many other cases of market conditions that generate quantities other than the allocatively efficient quantity. 

Click here to return to Question 13.01.












Answer to Question 13.03

If one curve lies above another, then the marginal costs depicted in the higher curve exceed the marginal costs depicted in the lower curve at any given quantity of production. So in order to depict social costs that are in excess of the private costs incurred by the producer, the social cost curve must lie above the market supply curve.

Click here to return to Question 13.03.













Answer to Question 13.04

Private sellers and private buyers interact in markets to determine equilibrium quantities and prices. The existence of external costs does not change the decisions of either private sellers or private buyers.

This answer is depicted in the graph below.

Equilibrium Outcomes in a Competitive Market with External Costs​

Click here to return to Question 13.04.





Answer to Question 13.05

At the equilibrium market quantity, the total marginal cost of production, exhibited by the social cost curve, is greater than the consumer's marginal benefit (from the demand curve)

This answer is depicted in the graph below.

Equilibrium Outcomes in a Competitive Market with External Costs​​

Click here to return to Question 13.05.





Answer to Question 13.06

An allocatively efficient quantity is the quantity at which the marginal cost of production equals the consumer's marginal benefit. In other words, it reflects the intersection between the marginal social cost curve and the consumer's demand curve, so (B).

This answer is depicted in the graph below.

Efficient Output for a Competitive Market with External Costs​

Click here to return to Question 13.06.





Answer to Question 13.08

Private sellers and private buyers interact in markets to determine equilibrium quantities and prices. The existence of external benefits does not change the decisions of either private sellers or private buyers.

This answer is depicted in the graph below.

Equilibrium Outcomes in a Competitive Market with External Benefits​​

Click here to return to Question 13.08.





Answer to Question 13.09

An allocatively efficient quantity is the quantity at which the marginal cost of production equals the consumer’s marginal benefit. In other words, it reflects the intersection between the marginal social benefit curve and the producer’s supply curve, so (D). 

This answer is depicted in the graph below.

A Competitive Market with External Benefits​​

Click here to return to Question 13.09.





Answer to Question 13.10

Compare the marginal social benefits with the producer’s marginal cost at the equilibrium market quantity. The benefits, derived from the marginal social benefit curve, are higher than the supplier’s costs at that point, derived from the supply curve. The market should produce more of this good – and keep producing as long as the social benefit exceeds the cost. When that is no longer true, the market will be at the efficient quantity.

Click here to return to Question 13.10.












Answer to Question 13.12

Suggestions one and four would make little sense. Requiring producers to produce less is changing the market in the wrong direction. A tax would also reduce production. You should be able to show that.

Click here to return to Question 13.12.













Answer to Question 13.13

After the subsidy, firms find that their costs of production have fallen by the amount of the subsidy, thereby shifting the supply curve down by the amount of the subsidy. The intersection of this new supply curve with the demand curve is Choice D. 

This answer is depicted in the graph below.

Equilibrium Quantities in a Market with External Benefits and Subsidies​​

Click here to return to Question 13.13.












Answer to Question 13.16

Homeowners who plant trees do not receive all the benefits of the increased numbers of trees. If there are external benefits (such as cleaner air, more enjoyable landscaping, or the capture of greenhouse gas emissions), the city is justified in subsidizing or providing trees for less than their costs.

Click here to return to Question 13.16.













Answer to Question 13.18

The government could add taxes to the market or otherwise enforce lower production levels. (Choices 1 and 4.)

Click here to return to Question 13.18.














Answer to Question 13.20

The government would have to mandate that there be no quantity produced greater than the allocatively efficient quantity in Figure 13.7. That means firms would be producing where the private marginal cost of production is less than the marginal benefit to consumers.

Click here to return to Question 13.20.













Answer to Question 13.21

The marginal costs of pollution reduction are increasing. Firms may know quick and easy ways to reduce pollution at first, but after that, it gets more difficult to figure out how to keep pollution down while still keeping production going.

Click here to return to Question 13.21.













Answer to Question 13.23

Pollution is not necessarily good, but there may be positive amounts of pollution where the costs of getting rid of the pollution are greater than the damages done by the pollution. In those cases, the optimal (or perhaps “good”) amount of pollution is a positive amount.

Click here to return to Question 13.23.














Answer to Question 13.24

It may well make sense in some cases to have zero pollution. If the costs to consumers of each additional amount of pollution (i.e., the marginal benefits of pollution reduction) are greater than the costs of eliminating the pollution, and this is true at all levels of pollution, then the pollution should be eliminated – and we will be better off as a result.

Click here to return to Question 13.24.













Answer to Question 13.25

There are a variety of possibilities. Each firm could reduce pollution by 25,000 tons. A second option would be for firm C to reduce its pollution to zero. A third might be for a combination of firms to reduce pollution where the cost is the least expensive. Which should we do?

Click here to return to Question 13.25.













Answer to Question 13.30

It depends on the marginal benefits of each option. If burning trash produces usable energy, then the extra costs may be justified. Or if landfills are overcrowded and unsightly, it may be worth it to spend more money burning trash. Absent these additional benefits from burning or costs to using landfills, it does not make sense.

Click here to return to Question 13.30.













Answer to Question 13.35

Public radio is a product rife with free riders—people who don’t donate to the station but listen to the programming anyway. More examples are detailed below.

Click here to return to Question 13.35.














Answer to Question 13.36

Again, public radio is a great example. Any number of people can consume this product without interfering with anyone else’s consumption of it. More examples are contained in the text below.

Click here to return to Question 13.36.













Answer to Question 13.37

Free wifi in an overcrowded café is an example. Anyone in the vicinity can use the wifi, but if everyone uses it, the service is overwhelmed, and the internet speed slows. Notice that if the wifi service has only a few users so that the whole bandwidth is not utilized, then this property doesn’t hold.

Click here to return to Question 13.37.













Answer to Question 13.38

Asteroid defense is a global good in the sense that every country in the world would benefit from not having its citizens annihilated. But it suffers from the free rider problem: even countries that do not contribute to an asteroid defense system would be able to use it. Thus, it is hard to convince individual countries to pony up. You heard the congressman! Ask Russia to pay for it!

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Answer to Question 13.39

If there is no marginal cost of producing additional quantities, and if consumers derive any marginal benefit from the good at all, then the allocatively efficient quantity of production is “as much as possible” and as many consumers as possible should consume the good.

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Answer to Question 13.40

Once the radio signal is broadcast, it is difficult to prohibit anyone from receiving the signal. Consumers do not need to pay to consume these goods, and one person’s consumption of broadcast radio does not affect any other person’s ability to consume the same. The solution that traditional broadcast radio has used is to charge advertisers for time and to use those revenues to cover their costs.

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Answer to Question 13.41

One possible outcome is if a profit-maximizing fishing fleet owned by a single company fishes the area. The fleet knows that it must be careful and manage its catch well, or the fish will soon disappear, and the company will go out of business.
The second scenario is one in which several smaller companies fish in the area. The fleet has been growing and is beginning to catch more than 1,000 tons. Each fishing boat knows that if it does not catch its share, someone else will. In order to protect their current profits, each boat begins to expand its fishing. As they all do that, the salmon begin to disappear.

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Answer to Question 13.42

Subsidizing fishing industries is exactly the wrong thing to do as it encourages more fishing, thereby worsening the fish population problem. The nature of the industry is such that fish are a common resource and production and consumption should be restricted, not encouraged.

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Answer to Question 13.43

The challenge here is to identify a market failure. If there is a legitimate economic role for government, it has to be because of external costs or benefits, a market with the characteristics of public goods markets, a common good market, a not-very-competitive market, lack of information and concerns with safety for consumers, or simply a goal of changing the income distribution that results from an otherwise normal market.

In this case, the most often stated goals are to help the small farmer – perhaps an effort to redistribute income – and to preserve farming and rural communities as a way of life – perhaps an external benefit of farming. In reality, the programs stem from a dramatic shift in our economy away from agriculture to manufacturing and services. In that shift, millions lost jobs and livelihoods as they were forced to move to cities and new jobs. The subsidy programs are largely a result of the old effort to help make the transition easier. (In fact, the original motivation for farm subsidies was to provide income during the Great Depression.) And they still exist, in part because subsidy recipients are highly motivated to keep them in place and can afford to pay lobbyists and other influencers to make their case to lawmakers.

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Answer to Question 13.45

Consumers will consume the allocatively efficient quantity if they can accurately estimate marginal utilities of goods. Government information that helps consumers more accurately estimate these utilities will reduce the amount of over- and under-consumption of goods and move consumers closer to consumption of the allocatively efficient amount.

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Answer to Question 13.46

Governments can serve to increase efficiency in markets with external costs or external benefits by introducing taxes or subsidies to producers (or consumers). They can also provide public goods that private markets cannot produce in efficient quantities and regulate consumption of common resources, which would otherwise be overused. There are other roles for government highlighted in Chapter 12: Regulation of Firms with Market Power and Chapter 15: Taxes.

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Answer to Question 13.47

There is no obvious rationale. It is not a public good. If the market for mohair is competitive and there are no external benefits, there is no justification for a subsidy. (The original justification was that mohair was used in military uniforms and coats and increased production was needed for military purposes.)

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Image Credits

[1] Image courtesy of AgnosticPreachersKid under CC BY-SA 3.0.

[1] Image courtesy of Roger Kidd under CC BY-SA 2.0.

[2] Image courtesy of oddharmonic under CC BY-SA 2.0.

[3] Image courtesy of zoetnet under CC BY 2.0.

[4] Image courtesy of Gabriel White under CC BY-SA 2.0.

When private markets do not produce an economically efficient allocation of resources. In other words, when the private market does not maximize total surplus.
Consider cases where the market produces a quantity other than the allocatively efficient quantity.
The costs of producing a good or service that are borne by individuals other than the producer or consumer.
The benefits received by individuals other than the producer or consumer.
Think of a vertical line on a supply and demand graph. This tells you the cost for a given quantity of production.
The marginal cost of production from society's point of view.
The marginal benefit of consumption from society's point of view.
Draw a vertical line on a supply and demand graph. This tells you the cost for a given quantity of production.
Would each of these options generate more or less production of the good in question?
Hint
Would you expect the planting of trees to have external costs or external benefits?
If prices are too low and quantities too high, how could the government intervene effectively?
What rule would the government have to set to get to the efficient outcome?
Are marginal costs of pollution increasing or decreasing with the amount of pollution reduced?
Why wouldn’t you reduce pollution to a number below 150,000 in the example above?
Make your argument in terms of marginal costs and marginal benefits.
How could 75,000 tons of pollution be eliminated from this town?
Use comparisons of marginal costs and marginal benefits to answer this question.
A good and service that can be consumed by only one person at a time. It is also possible to exclude non-buyers from consuming the goods.
What goods are open for use by any and everyone?
Do the free riders from the previous question interfere with others’ consumption of the good?
Now the trick is to name a good where consumers cannot be kept away, but where their use does interfere with the use of others.
A public good has two characteristics. First, it is difficult or impossible to exclude non-buyers from consuming the good. Second, consumers can consume a public good without interfering with others' consumption of the same good.
Who will pay for this service?
Remember the definition of allocative efficiency.
From whence do television and radio stations derive revenue?
A resource that can be consumed by only one producer or consumer at a time and is found in environments in which it is difficult to exclude nonpaying users.
How does this situation compare to the soft drink example?
What will happen to the quantity produced under a subsidy to fishing?
Is there a market failure in farm product markets?
How can consumers get closer to consuming the allocatively efficient quantity if their estimates of the marginal benefits are incorrect?
There were several economic justifications for government intervention in free markets in this chapter. What are they?
Does mohair have external costs or benefits? Can consumers be excluded from using it? Does it have zero marginal cost of production?