[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Review and Practice
SUMMARY
1. Government may have a role in the economy when markets
fail to produce an efficient outcome. When positive
or negative externalities exist, markets will not provide
an efficient outcome.
2. One way to deal with externalities is to assign clear-cut
property rights.
3. Governments may deal with environmental externalities
by imposing regulatory measures (the command and
control approach), levying taxes and granting subsidies,
or issuing marketable permits.
4. In a perfect market, natural resources are used up at an
efficient rate. However, privately owned resources may
be sold too soon, for two reasons. First, owners may fear
that if they do not sell the resources soon, new government
rules may prevent them from selling at all or, in
any case, may lower the return from selling in the future.
Second, interest rates facing owners may be high, so
they may value future income less than society does in
general. High interest rates lead to a faster exploitation
of natural resources.
KEY TERMS
social marginal cost
private marginal cost
Coase’s theorem
command and control approach
marketable permits
REVIEW QUESTIONS
1. Name several market failures. Why do economists see
the existence of these market failures as a justification
for government action?
2. Why will a free market produce too much of goods that
have negative externalities, like pollution? Why will a
free market produce too little of goods that have positive
externalities, like pollution controls?
3. What are the advantages and limitations of dealing with
externalities by assigning property rights?
4. What are the advantages of marketable permits over
command and control regulation? What are the advantages
of using taxes on polluting rather than subsidies
for pollution-abatement equipment?
5. How do markets work to allocate natural resources
efficiently? In what cases will markets fail to give the
correct signals for how quickly a resource like oil
should be depleted?
PROBLEMS
1. Marple and Wolfe are two neighboring dormitories.
Wolfe is considering giving a party with a very loud
band, which will have a negative externality in the form
of a sort of sound pollution for Marple. Imagine that the
school administration decides that any dormitory has
the right to prevent another dorm from hiring a band. If
the band creates a negative externality, how might the
residents of Wolfe apply the lessons of Coase’s theorem
to hire the band they want?
Now imagine that the school administration
decides that no dormitory can prevent another dorm
from hiring a band, no matter how loud. If the band provides
a negative externality, how might the residents of
Marple apply the lessons of Coase’s theorem to reduce
the amount of time they have to listen to the band?
How would your answer change if the band provided a
positive externality?
2. The manufacture of trucks produces pollution of various
kinds; for the purposes of this example, let’s call it all
“glop.” Producing a truck creates one unit of glop, and
glop has a cost to society of $3,000. Imagine that the
supply of trucks is competitive, and market supply and
demand are given by the following data:
Price (thousand $) 19 20 21 22 23 24 25
Quantity supplied 480 540 600 660 720 780 840
Quantity demanded 660 630 600 570 540 510 480
Graph the supply curve for the industry and the demand
curve. What are equilibrium price and output? Now
graph the social marginal cost curve. If the social cost of
glop were taken into account, what would be the new
equilibrium price and output?
If the government is concerned about the pollution
emitted by truck plants, explain how it might deal with
REVIEW AND PRACTICE ∂ 419