Chapter 14
Practice Quiz
Environmental Economics
1. Suppose the city of New Orleans discovered chemical compounds in its drinking water
that may cause cancer. Since New Orleans’s drinking water comes from the Mississippi
River, the source of these chemicals is the waste discharges of industrial plants upstream
from New Orleans. This is an example of
a. an external cost imposed on the citizens of New Orleans by the industrial plants
upstream.
b. a market failure where the market price of the output of these industrial plants does not
fully reflect the social cost of producing these goods.
c. an externality where the marginal social costs of producing these industrial goods
differ from the marginal private costs.
d. all of the above.
ANS:
d. The upstream firm is releasing chemicals into the water, an external cost to the citizens
of New Orleans. The upstream firm is not including these costs when pricing its product;
hence, the market price is too low. Marginal social costs would include the marginal
private cost of the industrial product (their costs of labor, capital, materials, etc.) and the
external cost of the chemicals released into the water. Choices (a), (b), and (c) each are
correct, so that all of the above is the correct choice.
2. A government policy that charges steel firms a fee per ton of steel produced (an
effluent charge) where the fee is determined by the amount of pollutants discharged into
the air or water will lead to
a. a decrease in the market equilibrium quantity of steel produced.
b. a decrease in the market equilibrium price of steel.
c. an increase in the market equilibrium price of steel.
d. the results in (a) and (b).
e. the results in (a) and (c ).
ANS:
e. Essentially, the government is employing an effluent tax to reduce pollution. The tax
increases the cost of production. Supply decreases, leading to a higher price and smaller
quantity. So choice (e), where (a) quantity decreases and (c) price increases, is the best
choice.
3. Social costs are
a. the full resource costs of an economic activity.
b. usually less than private costs.
c. the costs of an economic activity borne by the producer.
d. all of the above.
ANS:
a. Social costs include both private costs (the costs of the firm’s inputs, including labor,
capital, land, etc.) and external costs (the costs to third parties, such as pollution emitted
by the producer). Social costs are at least as large as private costs. Producers will not
consider external costs, which are a part of social costs, unless they are forced to do so by
government or court.
4. As a general rule, if pollution costs are external, firms will produce
a. too much of a polluting good.
b. too little of a polluting good.
c. an optimal amount of a polluting good.
d. an amount that cannot be determined without additional information.
ANS:
a. Private firms will make their production decision using private costs. If there are
external costs, social costs exceed private costs. If production decisions included external
costs, supply would be smaller than when private costs alone are considered. So if
external costs are ignored, the firm will produce too much, as compared to the social
efficient level.
5. Many economists would argue
a. the optimal amount of pollution is greater than zero.
b. all pollution should be eliminated.
c. the market mechanism can handle pollution without any government intervention.
d. central planning is the most efficient way to eliminate pollution.
ANS:
a. The optimal amount of pollution is where marginal social cost equals marginal social
benefit. This amount typically exceeds zero. The marginal cost of eliminating all
pollution would likely be very high. For example, we would have to eliminate all cars.
However, firms tend to ignore external costs such as pollution, in an unfettered market.
While government is likely to be needed, pollution has actually been worse in centrally
planned economies.
6. Which of the following used marketable pollution permits as an incentive for reducing
pollution?
a. The 1970 Clean Air Act
b. The Comprehensive Environmental Response, Compensation, and Liability Act of
1980
c. The 1990 Clean Air Act amendments
d. The Water Quality and Improvement Act of 1970
ANS:
c. The 1990 Clean Air Act was the first piece of federal legislation to introduce emissions
trading. It introduced this approach for sulfur emissions, thought to contribute to acid
rain.
7. The disposable diaper industry is perfectly competitive. Which of the following is
true?
a. Since the industry is perfectly competitive, price and quantity are at the socially
efficient levels.
b. Competitive price is higher and competitive quantity lower than the socially efficient
point.
c. Competitive price is higher and competitive quantity higher than the socially efficient
point.
d. Competitive price is lower and competitive quantity higher than the socially efficient
point.
ANS:
d. Disposable diapers have an external cost, to the extent that they are not biodegradable
and sit in landfills. Producers in a competitive market consider only private costs,
ignoring disposal issues. Similarly, consumers just want to prevent leaks that affect
them, but ignore leaks that affect landfills. So producers and consumers use private costs
and benefits. Social costs are higher, so that social supply is smaller. The competitive
price, based on private costs and benefits, is lower than the social cost. Competitive
quantity is larger, given the larger supply, than the socially efficient quantity.
8. An example of the command-and-control approach to environmental policy is
a. placing a tax on high-sulfur coal to reduce its use and the corresponding sulfur
emissions (which contribute to acid rain).
b. requiring electric utilities to install scrubbers to reduce sulfur dioxide emissions (which
contribute to acid rain).
c. allowing coal producers to buy and sell permits to allow sulfur emissions.
d. allowing individuals to sue coal producers if sulfur emissions exceed government-set
standard.
ANS:
b. Command-and-control is a regulation whereby the government establishes a pollution
target and dictates the method to achieve the target. An example is requiring scrubbers to
reduce sulfur emissions. Sulfur emission permits and effluent taxes are example of
incentive-based approaches. With taxes, for example, the firm can choose low-sulfur
coal to avoid the tax.
Exhibit 6 Profit-Maximizing Firm
Price per unit
MSC
P1
Demand
L
MPC APC
H
G
C
A
K
J
ASC
F
E
B
Q1
Q2 Q3
Quantity of output
Q4
18
9. The profit-maximizing firm in Exhibit 6 creates water and air pollution as a
consequence of producing its output of beef cattle. If pollution costs are borne by third
parties, the firm will maximize economic profit by choosing to
a. voluntarily incur costs to reduce its pollution.
b. produce at output rate Q3.
c. produce at output rate Q2.
d. produce at output rate Q4.
ANS:
d. The firm will produce at Q4 where demand (MR) intersects Private MC.
10. Use Exhibit 6 to complete the following: To maximize social welfare, the firm should
produce at output rate
a. Q1.
b. Q2.
c. Q3.
d. Q4.
ANS:
b. The firm will produce at Q2, where demand (MR) intersects Social MC.
Exhibit 7 Impact of Flights on House Value
Number
of Flights
Total
Profits
Marginal
Profits
Value of
Wilbur’s House
1
$10,000
$10,000
$100,000
2
3
4
18,000
24,000
28,000
8,000
6,000
4,000
95,000
90,000
85,000
5
30,000
2,000
80,000
11. As shown in Exhibit 7, if Orville has the property right to fly over Wilbur’s house,
but Wilbur is allowed to negotiate with Orville on the number of flights, what will be the
number of flights?
a. 2
b. 3
c. 4
d. 5
ANS:
b. At 3 flights, marginal profit for Orville is $6,000 and the value of Wilbur’s property
goes down by $5,000.
12. As shown in Exhibit 7, Wilbur has the property right to have no planes flying over his
house, but Orville is allowed to negotiate with Wilbur, what will be the number of
flights?
a. 2
b. 3
c. 4
d. 5
ANS:
b. At 3 flights, marginal profit for Orville is $6,000 and the value of Wilbur’s property
goes down by $5,000.
13. As shown in Exhibit 7, at the socially efficient number of flights, what will be the
market value of Orville’s house?
a. $100,000
b. $95,000
c. $90,000
d. $85,000
e. $80,000
ANS:
c. At 3 flights, this is the last number of flights that the marginal profits are greater than
the marginal costs (ie. the amount that Orville’s house declines in value).
14. The Tragedy of the Commons is said to arise because
a. individuals will fish so long as the marginal private costs equal the marginal private
benefits.
b. individuals will fish so long as the marginal social costs equal the marginal private
benefits.
c. individuals will convert open access property into private property.
d. individuals will convert open access property into common property.
ANS:
a. Individuals will use an open access resource to the point of exhaustion, basing their use
on private benefits while disregarding external costs to others.