Multiple Choice Questions

  1.	A well-maintained house and yard is an example of 

(a) a positive externality.
(b) a negative externality.
(c) moral hazard.
(d) adverse selection.
	 

  2.	The sum of the marginal costs of producing a product and the
correctly measured damage costs involved in the process of production
is the
	
(a) marginal external cost.
(b) marginal damage cost.
(c) marginal private cost.
(d) marginal social cost.
	 

  3.	If there are external costs in production and firms do not have to
factor these costs into their decisions, then firms will produce

(a) at the efficient level.
(b) an output level that is below the efficient level.
(c) an output level that is above the efficient level.
(d) an output level that is either above or below the efficient level.
	 

  4.	If the government taxes a steel company by an amount equal to the
damages of each successive ton of steel, then the steel company's marginal
cost curve is the same 	as the
	
(a) marginal damage cost curve.
(b) marginal social cost curve.
(c) marginal private cost curve.
(d) marginal benefit cost curve.
	 

  5.	Taxes on externality-producing activities

(a) are designed to eliminate externalities.
(b) will lead to a zero level of output.
(c) are simply meant to force decision makers to consider the full costs
    of their actions.
(d) are designed primarily as a way to raise money so that the government
    can compensate the victims of the externality.
	 

  6.	As the number of people receiving benefits from a good increases,
the tendency for people to be free-riders
	
(a) increases because as the size of the group gets larger, it is
    harder to detect free-riders.
(b) decreases because as the size of the group gets larger, the amount any
    one individual has to pay gets smaller.
(c) decreases because as the size of the group increases, it is easier to
    exclude people from consuming the good.
(d) increases because the good will become rival in consumption.
	 

  7.	Michael Jackson decides to give a concert in Central Park in New York
City. The concert organizers argue that the only way the concert can be
given in the park is if it is free. This is because the concert would have
the characteristic of being 

(a) nonexcludable. 
(b) rival in consumption. 
(c) both nonexcludable and rival in consumption. 
(d) a Samuelsonian good. 
	 

  8.	Once a public good is produced,

(a) everyone can consume a different amount depending upon their 
    willingness to buy the good.
(b) everyone consumes the same amount and everyone's willingness to pay is
    the same.
(c) everyone consumes the same amount, but the willingness to pay will be     
    different for different individuals.
(d) everyone can consume a different amount and pay different prices for
    the product.
	 

  9.	If a buyer or seller enters into an exchange with another party
who has more information, there has been
	
(a) moral hazard.
(b) adverse selection.
(c) a negative externality imposed.
(d) a free-rider problem.
	 

 10.	In the market for used motorcycles there are high quality
motorcycles and poor quality motorcycles. Potential buyers can not
determine prior to purchase whether the motorcycle is high quality or
low quality. Which of the following statements best describes what is
likely to happen in this market?
	
(a) The price of a used motorcycle will be very close to the value
    of a high quality motorcycle which will encourage people to sell
    high quality motorcycles.
(b) The price of a used motorcycle will be between the value of a high
    quality and low quality motorcycle. This will encourage people to
    withdraw high quality motorcycles from the market.
(c) This is an example of adverse selection since the buyer will have more     
    information about the quality of the used motorcycle than the seller
    will.
(d) Over time the price of a used motorcycle will increase in this
    market, since there is more of an incentive for owners of high
    quality motorcycles to sell than owners of low quality motorcycles.
	 
 	 
	 
 11.	Which of the following is an example of moral hazard?

(a) Individuals with the poorest driving records are the ones most
    likely to buy automobile insurance.
(b) You don't contribute to your public television station because
    your contribution would be such a small percentage of the station's
    budget.
(c) You choose not to vote since your vote will not change the outcome of
    the election.
(d) After you join a medical plan that covers all doctor's visits, you now
    start going to the doctor every time you get a cold.
	 
 12.	The idea that a voting scheme cannot be devised that respects
individual preferences and gives consistent, nonarbitrary results is known
as
	
(a) the impossibility theorem.
(b) the independence of irrelevant alternatives.
(c) adverse selection.
(d) moral hazard.
	 
   

PROBLEM 1:  Consider the following situation.  The small town of Noti has
two firms that cause air pollution: a lumber company and a trucking firm.
The two firms currently emit 16 tons of pollutants into the air each year
and the following table shows how much it would cost each firm to reduce
its pollution.


              Cost to reduce each ton of pollution                 

		      LUMBER CO.       TRUCKING CO.			
                       
1st Ton			$   1000	        $  900	
2nd			    2000		  1800
3rd 			    2200		  2700
4th			    2400		  3600
5th			    3000		  4600
6th			    3000		  6000
7th			    5000		 12000
8th                        20000                 50000      


1A) Now suppose that Noti wants to eliminate 10 tons of air pollution.
The first option Noti considers is to make both firms eliminate 5 tons of
pollution each.  What is the cost of pollution elimination for each firm
and the total combined cost for both firms (which represent the total cost
for society)?


Total cost for Lumber firm   		__________________
Total cost for Trucking firm		__________________
Total combined cost for both firms 	__________________


1B) Now suppose the town of Noti knows the costs of pollution elimination
for each firm as described in the table above.  How much would the town
make each firm eliminate their pollution to get the same amount of
pollution reduction for less combined cost across the two firms?   (The
reduction of pollution for the firms is not necessarily equal!)


Units of pollution reduction for Trucking firm: ___________________
Units of pollution reduction for Lumber firm:   ___________________
Total combined costs of pollution reduction for both firms: ________________


Explain why this solution in 1B) is more efficient than the solution in
1A).









1C) If instead, the town of Noti decides to have an auction for "rights to
pollute 1 ton" in order to reduce 10 tons of pollution, how many "rights
to pollute 1 ton" would Noti offer for sale?
______________________________

How many rights would the lumber firm buy? _______________________________

How many rights would the trucking firm buy?___________________________________




Which mechanism for reducing pollution is more efficient?  (that of 1B) or
1C) ?)  Explain why.