List 11.
Externalities and market inefficiency
Public goods and common resource
Task 1.
Consider the market for fire extinguishers.
a) Why might fire extinguishers exhibit positive externalities in consumption?
b) Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value
curve, the supply curve and the social-cost curve.
c) Indicate the market equilibrium level of output and the efficient level of output. Give an
intuitive explanation for why these quantities differ.
d) If the external benefit is $10 per extinguisher, describe a government policy that would result
in the efficient outcome.
Task 2.
Ringo loves playing rock and roll music at high volume. Luciono loves opera and hates rock and 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 the 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?
Task 3.
Greater consumption of alcohol leads to more motor vehicle accidents and thus imposes costs on
people who do not drink and drive.
a) Illustrate the market for alcohol, labeling the demand curve, the social-value curve, the
supply curve, the social-cost curve, the market equilibrium level of output, and the efficient
level of output.
b) On your graph, shade the area corresponding to the deadweight loss of the market
equilibrium (Hint: the deadweight loss occurs because some units of alcohol are consumed
for which the social cost exceeds the social value).
Task 4.
The river has two polluting firms on its banks. Both firms dump 100 tons of glop into the river each
year. The cost of reducing glop emissions per ton equals $10 for first company (A) and $100 for
second company (B). The local government wants to reduce overall pollution from 200 tons to 50
tons.
a) If the government knew the cost of reduction for each firm, what reductions would it impose
to reach its overall goal? What would be the cost to each firm and the total cost to the firms
together?
b) In a more typical situation, the government would not know the cost of pollution reduction
at each firm. If the government decided to reach its overall goal by imposing uniform
reductions on the firms, calculate the reduction made by each firm, the cost to each firm and
the total cost to the firms together.
c) Compare the total cost of pollution reduction in parts (a) and (b). If the government does not
know the cost of reduction for each firm, is there still some way for it to reduce pollution to
50 tons at the total cost you calculated in part (a)?
Microeconomics
Dr Anna Kowalska-Pyzalska
List 11.
Externalities and market inefficiency
Public goods and common resource
Task 5.
Think about the goods and services provided by your local government.
a) Using the classification learnt during the lecture, explain what category each of the following
goods falls into:
 Policy protection
 Snow plowing
 Education
 Rural roads
 City streets
b) Why do you think the government provides items what are not public goods?
Task 6.
Do you think Internet is a public good? Why, why not? Group discussion.
Task 7.
Julia loves watching soap-operas on her local public TV station, but she never sends any money to
support the station during their fund-raising drives.
a) What name do economists have for Julia?
b) How can the government solve the problem caused by people like Julia?
c) Can you think of ways the private market can solve this problem? How does the existence of
cable TV alter the situation?
d) Do you know any other examples of free riding?
Microeconomics
Dr Anna Kowalska-Pyzalska