Practice problems(P’s and A’s):
Ch. 10: Externalities
1. #8- Ringo loves playing rock-n-roll music at high volume. Luciano loves opera and hates rock-n-roll. Unfortunately, they are next-door neighbors in an apartment building with paper-thin walls. a) What is the externality here?
b) What command-and-control policy might the landlord impose? Could such a policy lead to an inefficient outcome? c) Suppose the landlord lets tenants do whatever they want. According to Coase theorem, how might Ringo and Luciano reach an efficient outcome on their own? What might prevent them from reaching an efficient outcome? Answers:
a) The externality is the noise or music
b) The landlord would limit the time and amount of music being played. This would lead to an inefficient outcome because the tenants are both losing. c) The two tenants would find an equal amount of time that each can play their respective music and take turns playing. Regulation by the landlord would prevent them from finding this equilibrium. 2. #12- There are three industrial firms in Happy Valley. FIRM
| INITIAL POLLUTION LEVEL
| COST OF REDUCING POLLUTION BY 1 UNIT
| 70 UNITS
| 80 UNITS
| 50 UNITS
The government wants to reduce pollution to 120 units, so it gives each firm 40 tradable pollution permits. a) Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation? b) How much higher would the costs of pollution reduction be if the permits could not be traded? Answers:
a) Firm C sells permits because it has the lowest pollution level and the lowest cost to reduce; Firm B would but permits because it has the highest pollution and highest cost to reduce; Total cost is unknown for you would need to know the price of a permit, which is unknown....
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