Externalities and the Environment

11 Externalities and the Environment CHECKPOINTS

Checkpoint 11.1 Checkpoint 11.2 Problem 1 Problem 1 Problem 2 Problem 2 Problem 3 Problem 3 Problem 4 Problem 4 Problem 5 Problem 5 Problem 6 Problem 7

Practice Problem 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 efficientquantity of pesticide? CHECKPOINT 11.1

Solution The quantity of pesticide produced is 30 tons a week. The efficient quantity of pesticide is 20 tons a week. CHECKPOINT 11.1

Practice Problem 2 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? CHECKPOINT 11.1

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. CHECKPOINT 11.1

Practice Problem 3 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? CHECKPOINT 11.1

Solution The factories produce the efficient quantity: 20 tons a week. CHECKPOINT 11.1

Practice Problem 4 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? CHECKPOINT 11.1

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. CHECKPOINT 11.1

Practice Problem 5 Pollution rules squeeze strawberry crop Last year, Ventura County farmers harvested nearly 12,000 acres of strawberries valued at more than $323 million (a quarter of the nation’s crop). To comply with the federal Clean Air Act, growers must use 50 percent less pesticide. It is estimated that strawberry output will fall by 60 percent. Source: USA Today, February 29, 2008 Explain how a limit on pesticide will change the efficiency of the strawberry industry. Would a cap-and-trade scheme be more efficient? CHECKPOINT 11.1

Solution If the limit on pesticide lowers the marginal external cost, then the strawberry industry will be more efficient. With a cap-and-trade scheme, the price of a cap will adjust until it equals the marginal external cost. With a cap-and-trade, the farmers’ marginal cost equals the marginal social cost, so a cap-and-trade scheme would be efficient. CHECKPOINT 11.1

Practice Problem 1 In an English village in 1375, cows graze on common pasture and can produce milk in the amounts shown in the table. The marginal private cost of a cow is zero. What is the marginal private benefit at each quantity of cows? CHECKPOINT 11.2

Solution The marginal private benefit (MB) of a cow is the average output of milk per cow. 100 cows produce 300 gallons of milk, so the average output per cow is 3 gallons. So the marginal private benefit of one of these 100 cows is 3 gallons of milk. CHECKPOINT 11.2

Practice Problem 2 In an English village in 1375, cows graze on common pasture and can produce milk in the amounts shown in the table. The marginal private cost of a cow is zero. What is the equilibrium number of cows? CHECKPOINT 11.2

Solution The marginal cost of a cow is zero, so the equilibrium number of cows is such that marginal private benefit equals marginal cost. So the equilibrium number of cows is 700, and no milk is produced. CHECKPOINT 11.2

Practice Problem 3 In an English village in 1375, cows graze on common pasture and can produce milk in the amounts shown in the table. The marginal private cost of a cow is zero. What is the marginal social benefit at each quantity of cows? CHECKPOINT 11.2

Solution The marginal social benefit is the marginal output of milk per cow. For example, an increase in the number of cows from 100 to 200 increases milk output from 300 to 500 gallons, so the marginal output per cow is 2 gallons. The marginal social benefit is 2 gallons of milk. CHECKPOINT 11.2

Practice Problem 4 In an English village in 1375, cows graze on common pasture and can produce milk in the amounts shown in the table. The marginal private cost of a cow is zero. What are the efficient number of cows and quantity of milk to produce? CHECKPOINT 11.2

Solution The efficient number of cows is the number at which the marginal social benefit equals the marginal cost of a cow (zero). The efficient number of cows is 350 (midway between 300 and 400 cows). The efficient quantity of milk is 600 gallons a day. CHECKPOINT 11.2

Practice Problem 5 In an English village in 1375, cows graze on common pasture and can produce milk in the amounts shown in the table. The marginal private cost of a cow is zero. If the common pasture were converted to private land and fenced off, how many cows would the landowner keep? CHECKPOINT 11.2

Solution If the common pasture were converted to private land and fenced off, the landowner would maximized milk output. Milk output is at a maximum when the landowner keeps 350 cows. CHECKPOINT 11.2

Practice Problem 6 In an English village in 1375, cows graze on common pasture and can produce milk in the amounts shown in the table. The marginal private cost of a cow is zero. If ITQs were issued for the efficient quantity of milk production, what would be the market price of an ITQ? CHECKPOINT 11.2

Solution The market price of an ITQ is the most it is worth. The market price of an ITQ would equal the marginal private benefit at the efficient quantity minus marginal cost (zero). The market price of an ITQ would be 1.75 gallons of milk (midway between 2.0 and 1.5 gallons per cow). CHECKPOINT 11.2

Practice Problem 7 Whaling hurts tourist industry Leah Garces, the director of programs at the World Society for the Protection of Animals, reported that whale watching is more economically significant and sustainable to people and communities than whaling. The global whale-watching industry is estimated to be a $1.25 billion business enjoyed by over 10 million people in more than 90 countries each year. Source: BBC, June 2, 2009 Describe the tradeoff facing communities that live near whaling areas. How might a thriving whale-watching industry avoid the tragedy of the commons? CHECKPOINT 11.2

Solution Communities in a whaling area face the tradeoff between whale hunting and developing a whale-watching business. With a thriving whale-watching industry, these communities will have an incentive to protect the whales and not overuse the natural resource. CHECKPOINT 11.2

Externalities and the Environment