Principles of economics 4th edition sloman test bank

Principles of Economics 4th Edition Sloman Test Bank Visit to download the full and correct content document: https://testbankdeal.com/dow nload/principles-of-economics-4th-edition-sloman-test-bank/

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The free market fails to provide public goods because: A) private firms cannot prevent people from using the good or service B) the goods and services are not demanded by consumers C) the private costs of production are greater than the social costs of production D) the costs of production are zero, therefore private firms cannot determine what output level to produce to maximise profits Answer: A Explanation:

A) B) C) D)

2) Imperfect information on the part of buyers of hybrid cars: A) contributes to market failure B) can be corrected by information provided by used car salesmen C) can be corrected by the use of advertising D) can be corrected by information provided on the websites of the car producers Answer: A Explanation:

3)

A) B) C) D)

4) Governments often subsidise goods and services that society appears to value more highly than the individual consumer does. These goods and services are called: A) private goods B) merit goods C) charities D) public goods Answer: B Explanation:

2)

A) B) C) D)

3) Which of the following defines an environmental charge?

A) a tax on output designed to charge for the adverse effects of production on the environment B) charges for using natural resources or for using the environment as a dump for waste C) the use of law to charge companies for failure to comply D) a pollution control that requires firms' emissions to reflect the levels that could be achieved from using the best available pollution control technology Answer: B Explanation:

1)

A) B) C) D)

1

4)

5) Externalities are a problem only if: A) decision makers do not take them into account B) the externalities impose a cost C) all firms are monopolistic D) all firms are perfectly competitive Answer: A Explanation:

A) B) C) D)

6) As fees for higher education in Australia continue to rise, and the sector is increasingly privatised, it is likely that the quantity of education produced and consumed will: A) be equal to the socially optimal level B) more closely reflect the socially optimal level C) exceed the socially optimal level D) be less than the socially optimal level Answer: D Explanation:

7)

A) B) C) D)

8) A situation where all individual markets are in equilibrium is called: A) total equilibrium B) dynamic equilibrium C) general equilibrium D) global equilibrium Answer: C Explanation:

6)

A) B) C) D)

7) Which of the following would be classified as an external cost (negative externality)?

A) You are not able to study at night because there is so much noise coming from the room next to yours.

B) A private firm will not provide national defence since it is impossible to confine the benefits to only those individuals who have paid for it.

C) When you purchase a product, the cost is higher than you originally anticipated.

D) As more firms began hiring computer programmers, the salaries of computer programmers increased and therefore the firm's cost of production increased.

Answer: A Explanation:

5)

A) B) C) D)

2

8)

9) Relative to a competitively organised industry, a monopoly: A) produces less output, charges lower prices and earns only a normal profit B) produces more output, charges higher prices and earns economic profit C) produces less output, charges higher prices and earns economic profit D) produces less output, charges lower prices and earns economic profit Answer: C Explanation:

A) B) C) D)

10) Three of the following are advantages of electronic road pricing. Which one is not?

A) The charge can be varied according to the level of congestion.

B) The charge can be varied according to the time of day.

C) The socially efficient rate to charge can easily be ascertained.

D) The revenues can be used to subsidise public transport.

Answer: C Explanation:

11)

A) B) C) D)

12) When the marginal social cost of the production of a good is ________ than the marginal social benefit, ________ should be produced.

A) less than; more B) less than; less C) more than; more D) more than; the same amount Answer: A Explanation:

10)

A) B) C) D)

11) To correct for an external benefit, the government should: A) set a tax equal to the amount by which marginal private cost exceeds the marginal social cost B) set a tax equal to the amount by which marginal social cost exceeds the marginal private cost C) provide firms with a subsidy for the amount by which marginal private benefit exceeds the marginal social benefit D) provide firms with a subsidy for the amount by which marginal social benefit exceeds the marginal private benefit Answer: D Explanation:

9)

A) B) C) D)

3

12)

13) Imperfect information on the part of buyers and sellers: A) remains a barrier to achieving efficiency, in many industries B) will not stop the economy from achieving efficiency, assuming the other conditions for efficiency hold C) cannot persist in a market economy D) is no longer a problem due to the effective enforcement of advertising standards Answer: A Explanation:

A) B) C) D)

14) Assume that the marginal cost of producing steel does not include the cost of the damage to the environment as a result of producing steel. By producing where P=MC, the firm will be producing: A) the efficient amount of steel B) a zero quantity of steel C) more than the efficient amount of steel D) less than the efficient amount of steel Answer: C Explanation:

15)

A) B) C) D)

16) Which of the following would be an example of an external benefit?

A) The government spends a million dollars on improving national parks.

B) A firm has just obtained permission to open a landfill site on property that is adjacent to your home.

C) More people start to ride the bus and as a result air pollution is reduced.

D) Firms are able to reduce their costs of production by using a more efficient technology.

Answer: C Explanation:

14)

A) B) C) D)

15) Market failure is used to describe: A) the failure of the market economy to provide an equal distribution of income to all citizens B) firms which go bankrupt C) an economic crisis D) the failure of the market to provide an efficient quantity of a good and service Answer: D Explanation:

13)

A) B) C) D)

4

16)

17) Which of the following is NOT a source of 'failure' of the free market?

A) imperfectly competitive markets B) external costs and benefits C) fast market adjustment to disequilibrium D) lack of knowledge by consumers Answer: C Explanation:

A) B) C) D)

18) In a perfectly competitive market where there are no externalities: A) marginal social cost will be greater than price B) marginal social benefit will equal marginal social cost C) marginal social benefit will be greater than price D) price will be greater than marginal social benefit Answer: B Explanation:

19)

A) B) C) D)

20) Which of the following is not a reason for governments to provide merit goods?

A) providing greater equality of opportunity B) protecting firms from poor investment decisions C) protecting consumers from poorly informed decisions D) protecting children from the decisions made by poorly informed parents Answer: B Explanation:

18)

A) B) C) D)

19) The deadweight loss associated with monopoly compared to perfect competition is comprised of: A) a loss of consumer surplus only B) a loss of consumer surplus and a loss of producer surplus C) a loss of private surplus D) a loss of producer surplus only Answer: B Explanation:

17)

A) B) C) D)

5

20)

21) Public goods are characterised by being non-rival in consumption, therefore: A) they are illegal B) they are very expensive, thus the private sector cannot provide them C) the private sector may not provide them because they cannot exclude those who do not pay D) the government cannot produce them Answer: C Explanation:

A) B) C) D)

22) General equilibrium occurs when ________ in all markets.

A) prices are fair B) consumers are satisfied C) firms make profits D) demand equals supply Answer: D Explanation:

23)

A) B) C) D)

24) Bill sells Mary a worthless coin that Bill incorrectly told Mary 'belonged to an ancient Persian king and is of enormous value to coin collectors'. Economists would call this an: A) efficient exchange, assuming Bill was not intentionally trying to trick Mary B) inefficient exchange because there were externalities involved C) efficient exchange since any type of voluntary exchange promotes efficiency D) inefficient exchange since at least one party used false market information Answer: D Explanation:

22)

A) B) C) D)

23) From the list below, the best example of a good that is non-excludable but is rival in consumption would be: A) transmission of television programs B) national defence C) fishing waters D) street lighting Answer: C Explanation:

21)

A) B) C) D)

6

24)

25) One role of the Australian Competition and Consumer Commission (ACCC) is to: A) prevent mergers between companies B) regulate the use of public goods C) recommend cuts in tariff protection to industries D) evaluate potential mergers between companies Answer: D Explanation:

A) B) C) D)

26) Producer surplus: A) is equal to total cost minus total revenue B) is the difference between the price producers would have been willing to accept for a good and the price they actually receive C) is the difference between the price producers would have been willing to pay for a good and the price they actually do pay D) is represented by the area above the price line and below the demand curve Answer: B Explanation:

27)

A) B) C) D)

28) Social efficiency occurs when: A) unemployment is low and prices are stable B) marginal social benefits of an activity are equal to the marginal social costs C) all markets are in equilibrium D) the marginal social cost of an activity is greater than the marginal social benefit Answer: B Explanation:

26)

A) B) C) D)

27) An economist has estimated that the maintenance of a public park costs $25 000 a year and that the public park generates $30 000 a year in revenue for merchants near the park. From society's point of view, the maintenance of this park is: A) inefficient because the park has no competition B) potentially efficient because the value of the gains exceeds the value of the losses C) inefficient because the additional revenues generated by the park are so low D) inefficient, because everyone in the community pays taxes to support the park, but only the merchants near the park benefit Answer: B Explanation:

25)

A) B) C) D)

7

28)

29) Assume that price underestimates the value that society places on flu vaccine. If firms produce where P=MC, firms will be producing: A) the output where consumer surplus is zero B) more than the efficient amount of flu vaccine C) the efficient amount of flu vaccine D) less than the efficient amount of flu vaccine Answer: D Explanation:

A) B) C) D)

30) Common resources are characterised by: A) provision by the government C) non-rivalry Answer: B Explanation:

B) non-excludability D) both B and C

32)

A) B) C) D)

33) If non-payers cannot be excluded from consuming a good this gives rise to the: A) pubic good problem B) free rider problem C) private good problem D) fallacy of composition problem Answer: B Explanation:

31)

A) B) C) D)

32) If an external cost arises in the production of paint: A) the free market will not produce enough paint B) too much paint will be produced C) painting competitions should be organised in local schools to use up the excess paint D) the government should subsidise the production of paint Answer: B Explanation:

30)

A) B) C) D)

31) Environmentally harmful effects often tend to be long term, even though the benefits of using the environment are almost immediate. This is an example of what type of market failure?

A) inter-generational problems B) externalities C) a common resource D) ignorance Answer: A Explanation:

29)

A) B) C) D)

8

33)

34) Because public goods are characterised by being collectively consumed: A) the government cannot produce them B) they are very expensive, thus the private sector cannot provide them C) the private sector may not provide them because they cannot exclude those who do not pay D) they are illegal Answer: C Explanation:

A) B) C) D)

35) Suppose a company moves its most polluting production to a factory in a developing country where it knows environmental regulation is less strict than in its home location. In the new location the firm's output is likely to: A) not relevant as the company is producing outside its home country B) be less than the efficient level of output C) be greater than the efficient level of output D) be less than the efficient level of output as an infinite increase in output would benefit a developing economy Answer: C Explanation:

36)

A) B) C) D)

37) In order to induce a more socially optimal level of output governments can ________ goods associated with negative externalities and ________ goods associated with positive externalities.

A) tax; subsidise B) subsidise; tax C) subsidise; subsidise D) tax; tax Answer: A Explanation:

35)

A) B) C) D)

36) Your next-door neighbour has a beautiful flower garden. However, you are allergic to flowers and cannot use your patio because of the flower pollen that drifts into it. In this case, the flower garden is an example of: A) a good that provides an external benefit B) market power C) a good that imposes an external cost D) a public good Answer: C Explanation:

34)

A) B) C) D)

9

37)

38) An external cost of production will occur when: A) common property resources exist B) public goods are not provided by the free market C) a firm does not consider the total social cost of production when choosing what level of output to produce D) a firm does not consider the total social benefit of production when choosing what level of output to produce Answer: C Explanation:

A) B) C) D)

39) Which of the following is NOT an example of an externality?

A) exhaust fumes from cars B) a lack of competition in the market C) your enjoyment of your neighbour's beautiful garden D) individuals paying for child immunisation Answer: B Explanation:

40)

A) B) C) D)

41) Street signs are an example of a good characterised by ________ and ________.

A) non-rivalry; non-excludability B) rivalry; non-excludability C) excludability: rivalry D) non-rivalry; excludability Answer: A Explanation:

39)

A) B) C) D)

40) Which of the following is not a characteristic of a tradable permit system of pollution control?

A) Firms are not permitted to sell their pollution permits to other firms.

B) Firms can emit pollution above their permitted level if they are able to buy a permit from another firm.

C) It combines both regulations and market-based systems.

D) The permit allows firms to emit pollution up to a pre-determined level.

Answer: A Explanation:

38)

A) B) C) D)

10

41)

42) Residents in the Hunter Valley of New South Wales claim that open cut coal mining is linked to high rates of asthma amongst children in the area. This health problem is: A) an external benefit of the local coal mining B) estimated to be less than the economic benefits of the coal mining C) an external cost of the local coal mining D) a private cost of coal production Answer: C Explanation:

A) B) C) D)

43) When the social benefit of production exceeds the private benefit of production: A) there is not enough of the good being produced B) the government should regulate the use of the common property resource C) there is too much of the good being produced D) there will be incidental costs from production Answer: A Explanation:

44)

A) B) C) D)

45) If the production of a product is associated with an external benefit, and the firm does not consider the external benefit when deciding how much to produce, then the firm will produce: A) the efficient level of output, as long as P = MC B) the efficient level of output, as long as the firm is perfectly competitive C) an output level that is greater than the efficient one D) an output level that is less than the efficient one Answer: D Explanation:

43)

A) B) C) D)

44) Which of the following is NOT an advantage of taxing negative externalities?

A) It is often difficult to accurately measure external costs such as pollution costs.

B) The tax provides a financial incentive for a firm to decrease the level of the negative externality.

C) Taxes force the producer of the externality to pay for the cost of the externality.

D) The tax internalises the externality.

Answer: A Explanation:

42)

A) B) C) D)

11

45)

46) If an industry changes from being highly competitive to a monopoly, this change can be represented by the: A) loss in consumer surplus plus the loss in producer surplus B) loss in producer surplus minus the gain in consumer surplus C) gain in producer surplus plus the gain in consumer surplus D) loss in consumer surplus plus the gain in producer surplus plus the deadweight loss Answer: D Explanation:

46)

A) B) C) D)

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

47) Correctly complete the sentences below from the options which follow.

Statement (a) If the MSC > the MSB then: (b) If the MSB > the MSC, then: (c) If the MSC = MC, then:

47)

Answer (i) the appropriate level of output is being produced that will lead to social efficiency. (ii) insufficient output will be produced by the private sector for social efficiency to be achieved. (iii) too much output will be produced by the private sector for social efficiency to be achieved.

Answer: (a) iii (b) ii (c) i Explanation: 48) What steps can the government take to help alleviate pollution using market forces?

48)

Answer: Taxes imposed on firms can internalise the external cost created by the production process. Another option would be the use of tradable permits, which will allow the market to set the price for the 'right' to pollute.

Explanation: 49) A firm produces an output level at which price is greater than marginal cost. Explain why this is inefficient.

49)

Answer: It is inefficient because the value that society places on using these resources to produce this product is greater than the cost of using resources to produce the product.

Explanation: 50) Use a diagram to illustrate the concepts of consumer and producer surplus.

Answer: Students should draw a demand and supply diagram, correctly labelled with price on the vertical axis and quantity on the horizontal. The area above the price line and below the demand curve represents consumer surplus. It is the amount consumers would have been willing to pay for a good but did not have to because they paid the equilibrium price. Producer surplus is the triangle below the price line and above the supply curve. This area represents the price producers would have been willing to accept for a good but did not have to as they received the equilibrium price.

Explanation:

12

50)

51) Explain the factors that can make it difficult for governments to set optimal levels of taxes and regulations to correct for pollution.

51)

Answer: It is difficult to determine what society perceives as the optimal level of emissions, for example, the solution may require global agreements, which can be difficult to reach and enforce. It is also difficult to measure the costs of pollution in money terms in order to levy taxes that accurately internalise pollution costs. For example, what is the cost of acid rain and what firms are responsible for what quantities of this type of pollution?

Explanation: 52) What is the free rider problem and how does government action help to overcome it?

52)

Answer: If non-payers cannot be excluded from the consumption of a good or service, this gives rise to the free-rider problem. All consumers have an incentive not to pay, in the expectation that others will pay, and the non-payers will then be able to consume the good at zero price. The free-rider problem means such a good or service is unlikely to be provided by a private sector firm.

Explanation: 53) Under what circumstances will electronic road pricing be most effective in reducing the level of traffic congestion?

53)

Answer: When there are ready alternatives for the motorist: either in terms of altering the timing of journeys, or the route, or the means of transport.

For example, road pricing will be more effective if there is an attractive form of public transport available.

Explanation: 54) Use a diagram to illustrate and explain how monopoly market power impacts the distribution of consumer and producer surplus compared to a perfectly competitive outcome?

54)

Answer: Students should draw a diagram similar to Figure 7.4 on page 163 of the text. The monopoly firm produces less than the perfectly competitive firm and charges a higher price. Consumer surplus is reduced (to area 1 in the diagram). Producer surplus increases (area 2 in the diagram), and a deadweight welfare loss is incurred.

This is equivalent to areas 3 and 5 in the diagram.

Explanation: 55) Explain what economists mean when they refer to 'negative externalities'.

Answer: A negative externality is a cost which occurs in the production of a good that falls on a third party. The third party does not benefit either from the production or the consumption of the good. For example, suppose coal is produced in the Hunter Valley of New South Wales and exported to China. Most of the residents of the Hunter Valley do not benefit from either the consumption or the production of the coal, but must bear a third party cost from the pollution associated with the mining.

Explanation:

13

55)

56) Using examples, explain the difference between a public good and a merit good.

56)

Answer: A public good has the characteristics of non-excludability and non-rivalry. This means that firstly it is not possible to provide a good or service to one person without it being available for others and secondly that the consumption of a good by one person will not prevent others from enjoying it. Together these imply that public goods will not be provided by the market. Examples include national defence and street lights.

Merit goods, on the other hand, are excludable and rival. You can prevent others from consuming them and if one person consumes the good or service, others can be prevented from doing so. A merit good is a good that the government feels that consumers undervalue and hence it will be under-consumed if it is not provided free or subsidised. Examples include healthcare and education. Despite being provided by the government, they are not public goods.

Explanation: 57) Provide some arguments for government intervention in the working of the economic system.

57)

Answer: 1. To take account of the existence of externalities 2. To subsidise merit goods 3. To provide for the production of public goods 4. To offset the imperfect information available to individuals and firms 5. To correct imperfections in markets Explanation: 58) Explain why an external benefit is likely to be associated with the purchase of smoke detectors. How may this externality be internalised?

58)

Answer: An individual using a smoke detector may lead to early fire detection, thus preventing fire spreading to other houses, and therefore benefiting others who were not involved in the purchase of the smoke detector. To internalise the externality, a subsidy could be provided which would increase the quantity of smoke detectors demanded to more closely reflect the socially efficient level.

Explanation: 59) Correctly complete the sentences below from the options which follow.

Statement (a) Private efficiency in consumption is where: (b) Efficiency in production for the producer is where: (c) Social efficiency in the market is where:

59)

Answer (i) marginal social benefit (MSB) equals marginal social cost (MSC). (ii) price equals marginal utility (MU). (iii) marginal cost (MC) equals price.

Answer: (a) ii (b) iii (c) i Explanation: TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

60) Non-rivalry means that one extra person using the good will not deplete it.

Answer: True Explanation:

False

14

60)

61) Public goods are non-rival in consumption and non-excludable.

Answer: True Explanation:

False

62) A tax set equal to the marginal social cost of production can correct for an external cost from a production process.

Answer: True Explanation:

70)

False

71) The free-rider problem arises because of the non-rivalry characteristic of public goods.

Answer: True Explanation:

69)

False

70) The deadweight loss of monopoly refers to the loss of consumer surplus caused by the monopolist's pricing and output decisions.

Answer: True Explanation:

68)

False

69) Tradable permits are a mix of regulation and market-based systems.

Answer: True Explanation:

67)

False

68) Cost-benefit analysis looks at the social costs and benefits of proposed actions.

Answer: True Explanation:

66)

False

67) A free rider is someone who cannot be made to pay for consuming something that other people have paid for.

Answer: True Explanation:

65)

False

66) If the marginal social cost of producing a good is less than the marginal social benefit, then more of the good should be produced.

Answer: True Explanation:

64)

False

65) The goal of equity is realised when income is equally distributed amongst the citizens of a nation.

Answer: True Explanation:

63)

False

64) A common resource is a resource that without government intervention would have no access restrictions.

Answer: True Explanation:

62)

False

63) Government market intervention can reduce market efficiency.

Answer: True Explanation:

61)

False

15

71)

72) Resale price maintenance involves a supplier specifying a minimum price at which a product can be sold, therefore it is beneficial for consumers.

Answer: True Explanation:

False

73) Sporting facilities are considered by the Australian government to be merit goods.

Answer: True Explanation:

78)

False

79) Higher education facilities are considered by the Australian government to be merit goods.

Answer: True Explanation:

77)

False

78) The results of a decision which affect people other than the decision-taker are called externalities.

Answer: True Explanation:

76)

False

77) A profit-maximising monopolist will normally produce a socially efficient level of output.

Answer: True Explanation:

75)

False

76) Social efficiency occurs in the market where marginal private benefit equals marginal social cost.

Answer: True Explanation:

74)

False

75) The difference between the maximum amount a person is willing to pay for a good and its current market price is the consumer surplus.

Answer: True Explanation:

73)

False

74) Taxing externalities such as pollution provides a financial incentive for firms to decrease pollution.

Answer: True Explanation:

72)

79)

False

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

80) Until quite recently the Australian government provided higher education free of charge to Australian students.

Explain the economic argument for free higher education.

Answer: Many economists believe higher education is a good with positive externalities so that the social benefits exceed the benefits to the individuals who undertake higher education. If this is indeed the case, the quantity of education provided by the market would be less than the socially efficient outcome. Higher education could therefore be subsidised in order to increase the quantity consumed, or, as in former times in Australia, the government might decide to simply provide the good free of charge. Some reasons for this decision included protecting students from poor decision making by their parents; ensuring the workforce was well skilled and providing equality of opportunity to all Australians.

16

81) Outline and critically evaluate the use of taxes to correct for external pollution costs arising from production.

Answer: Where production of a good also involves pollution, economists describe the pollution as an externality.

It is an external cost to society. The quantity of the good produced is therefore said to be greater than the socially optimal quantity because the external cost of the pollution is not included in the firm's production costs. By levying a tax equal to the cost of the pollution, the firm can be forced to internalise the cost. Students can draw a diagram similar to Figure 7.5 on page 167 of the text to illustrate this theoretical approach. The problem in practice is that costs of pollution are difficult to calculate accurately in order to levy the tax. There are many different types of pollution, which would all have to be separately measured according to their costs to society. Sometimes it might be theoretically possible to calculate costs of pollution, for example, in terms of health care costs incurred, but in practice this is normally impossible. Governments therefore often prefer approximate taxes or more simply, anti pollution legislation.

82) In what ways does the market system fail to provide protection for the environment?

Answer: There are major externalities associated with the environment, meaning that the costs of using it to pollute are invariably borne by others. The marginal social cost is larger than the private cost and hence it is overused. It also has elements of a public good as many parts of the environment are not privately owned, they are non-excludable and hence overused. Most environmental resources, however, are scarce and therefore also rivalrous in consumption. Ignorance is also a market failure here, as much environmental damage has been done without knowledge, e.g. the use of aerosols before the 1980s. Even if companies want to take action to counter environmental damage, factors of production are relatively immobile in the short run, hence time lags will be an issue. There is also the problem of the costs of environmental damage not being truly felt until the long term, whereas the benefits of using/damaging the environment are much more immediate. We place a larger value on the short-term benefits than on the long-term costs, hence there is a trade-off.

83) Explain how tradeable permits could be used to reduce carbon emissions. (Restrict your discussion to a national level).

Answer: The appropriate government department uses available scientific evidence to determine an acceptable level of carbon emissions for the nation as a whole, both in the present, and in terms of reductions over time. Individual carbon emitting entities are then allocated an allowed emission level for the present, which is normally reduced over time. Divisible permits are then allocated on the basis of the allowed emissions. If firms are able to reduce their emissions below the allocated level, they are able to sell their unused permits in tradeable permit markets. The permit prices should be determined by the interaction of demand and supply in the market for tradeable permits.

Firms which can reduce emissions relatively cost effectively have an incentive to do so in order to profit from the sale of their permits. Those firms in industries where costs of emission reduction are higher may emit beyond their allocations by buying additional permits. This results in efficiency in emission reduction.

84) Why is ignorance and poor decision making a cause of market failure?

Answer: In the model of perfect competition, market participants are assumed to be well informed with respect to the price and characteristics of the products they purchase and are therefore able to make well informed decisions. In reality, consumers are often ill informed and therefore make less than optimal decisions.

This could be because some goods are complex, or consumers buy them infrequently, or are confused by misleading advertising. Governments may try to remedy this, for example, through high taxes on goods which are harmful such as cigarettes.

17

85) What are public goods, and why won't the free market provide them?

Answer: Public goods are characterised by being non-rival and non-excludable. Non-rivalry means that the consumption by one person does not deplete the quantity of the good available for others.

Non-excludability means non-payers cannot be excluded from consumption and leads to the free-rider problem. Free-riders are non-payers who 'free-ride' on the payment of others. Private firms are therefore unlikely to earn a profit providing such goods, and hence they are often provided by the government.

18

Answer Key Testname: C7

1) A 2) A 3) B 4) B 5) A 6) D 7) A 8) C 9) C 10) C 11) D 12) A 13) A 14) C 15) D 16) C 17) C 18) B 19) B 20) B 21) C 22) D 23) C 24) D 25) D 26) B 27) B 28) B 29) D 30) B 31) A 32) B 33) B 34) C 35) C 36) C 37) A 38) C 39) B 40) A 41) A 42) C 43) A 44) A 45) D 46) D 47) (a) iii (b) ii (c) i 48) Taxes imposed on firms can internalise the external cost created by the production process. Another option would be the use of tradable permits, which will allow the market to set the price for the 'right' to pollute.

19

Answer Key Testname: C7

49) It is inefficient because the value that society places on using these resources to produce this product is greater than the cost of using resources to produce the product.

50) Students should draw a demand and supply diagram, correctly labelled with price on the vertical axis and quantity on the horizontal. The area above the price line and below the demand curve represents consumer surplus. It is the amount consumers would have been willing to pay for a good but did not have to because they paid the equilibrium price. Producer surplus is the triangle below the price line and above the supply curve. This area represents the price producers would have been willing to accept for a good but did not have to as they received the equilibrium price.

51) It is difficult to determine what society perceives as the optimal level of emissions, for example, the solution may require global agreements, which can be difficult to reach and enforce. It is also difficult to measure the costs of pollution in money terms in order to levy taxes that accurately internalise pollution costs. For example, what is the cost of acid rain and what firms are responsible for what quantities of this type of pollution?

52) If non-payers cannot be excluded from the consumption of a good or service, this gives rise to the free-rider problem.

All consumers have an incentive not to pay, in the expectation that others will pay, and the non-payers will then be able to consume the good at zero price. The free-rider problem means such a good or service is unlikely to be provided by a private sector firm.

53) When there are ready alternatives for the motorist: either in terms of altering the timing of journeys, or the route, or the means of transport.

For example, road pricing will be more effective if there is an attractive form of public transport available.

54) Students should draw a diagram similar to Figure 7.4 on page 163 of the text. The monopoly firm produces less than the perfectly competitive firm and charges a higher price. Consumer surplus is reduced (to area 1 in the diagram).

Producer surplus increases (area 2 in the diagram), and a deadweight welfare loss is incurred. This is equivalent to areas 3 and 5 in the diagram.

55) A negative externality is a cost which occurs in the production of a good that falls on a third party. The third party does not benefit either from the production or the consumption of the good. For example, suppose coal is produced in the Hunter Valley of New South Wales and exported to China. Most of the residents of the Hunter Valley do not benefit from either the consumption or the production of the coal, but must bear a third party cost from the pollution associated with the mining.

56) A public good has the characteristics of non-excludability and non-rivalry. This means that firstly it is not possible to provide a good or service to one person without it being available for others and secondly that the consumption of a good by one person will not prevent others from enjoying it. Together these imply that public goods will not be provided by the market. Examples include national defence and street lights.

Merit goods, on the other hand, are excludable and rival. You can prevent others from consuming them and if one person consumes the good or service, others can be prevented from doing so. A merit good is a good that the government feels that consumers undervalue and hence it will be under-consumed if it is not provided free or subsidised. Examples include healthcare and education. Despite being provided by the government, they are not public goods.

57) 1. To take account of the existence of externalities 2. To subsidise merit goods 3. To provide for the production of public goods 4. To offset the imperfect information available to individuals and firms 5. To correct imperfections in markets 58) An individual using a smoke detector may lead to early fire detection, thus preventing fire spreading to other houses, and therefore benefiting others who were not involved in the purchase of the smoke detector. To internalise the externality, a subsidy could be provided which would increase the quantity of smoke detectors demanded to more closely reflect the socially efficient level.

59) (a) ii (b) iii (c) i 60) TRUE 61) TRUE 62) FALSE 63) TRUE 20

Answer Key Testname: C7

64) TRUE 65) FALSE 66) TRUE 67) TRUE 68) TRUE 69) TRUE 70) FALSE 71) FALSE 72) FALSE 73) TRUE 74) TRUE 75) TRUE 76) FALSE 77) FALSE 78) TRUE 79) FALSE 80) Many economists believe higher education is a good with positive externalities so that the social benefits exceed the benefits to the individuals who undertake higher education. If this is indeed the case, the quantity of education provided by the market would be less than the socially efficient outcome. Higher education could therefore be subsidised in order to increase the quantity consumed, or, as in former times in Australia, the government might decide to simply provide the good free of charge. Some reasons for this decision included protecting students from poor decision making by their parents; ensuring the workforce was well skilled and providing equality of opportunity to all Australians.

81) Where production of a good also involves pollution, economists describe the pollution as an externality. It is an external cost to society. The quantity of the good produced is therefore said to be greater than the socially optimal quantity because the external cost of the pollution is not included in the firm's production costs. By levying a tax equal to the cost of the pollution, the firm can be forced to internalise the cost. Students can draw a diagram similar to Figure 7.5 on page 167 of the text to illustrate this theoretical approach. The problem in practice is that costs of pollution are difficult to calculate accurately in order to levy the tax. There are many different types of pollution, which would all have to be separately measured according to their costs to society. Sometimes it might be theoretically possible to calculate costs of pollution, for example, in terms of health care costs incurred, but in practice this is normally impossible. Governments therefore often prefer approximate taxes or more simply, anti pollution legislation.

82) There are major externalities associated with the environment, meaning that the costs of using it to pollute are invariably borne by others. The marginal social cost is larger than the private cost and hence it is overused. It also has elements of a public good as many parts of the environment are not privately owned, they are non-excludable and hence overused. Most environmental resources, however, are scarce and therefore also rivalrous in consumption.

Ignorance is also a market failure here, as much environmental damage has been done without knowledge, e.g. the use of aerosols before the 1980s. Even if companies want to take action to counter environmental damage, factors of production are relatively immobile in the short run, hence time lags will be an issue. There is also the problem of the costs of environmental damage not being truly felt until the long term, whereas the benefits of using/damaging the environment are much more immediate. We place a larger value on the short-term benefits than on the long-term costs, hence there is a trade-off.

21

Answer Key Testname: C7

83) The appropriate government department uses available scientific evidence to determine an acceptable level of carbon emissions for the nation as a whole, both in the present, and in terms of reductions over time. Individual carbon emitting entities are then allocated an allowed emission level for the present, which is normally reduced over time.

Divisible permits are then allocated on the basis of the allowed emissions. If firms are able to reduce their emissions below the allocated level, they are able to sell their unused permits in tradeable permit markets. The permit prices should be determined by the interaction of demand and supply in the market for tradeable permits.

Firms which can reduce emissions relatively cost effectively have an incentive to do so in order to profit from the sale of their permits. Those firms in industries where costs of emission reduction are higher may emit beyond their allocations by buying additional permits. This results in efficiency in emission reduction.

84) In the model of perfect competition, market participants are assumed to be well informed with respect to the price and characteristics of the products they purchase and are therefore able to make well informed decisions. In reality, consumers are often ill informed and therefore make less than optimal decisions. This could be because some goods are complex, or consumers buy them infrequently, or are confused by misleading advertising. Governments may try to remedy this, for example, through high taxes on goods which are harmful such as cigarettes.

85) Public goods are characterised by being non-rival and non-excludable. Non-rivalry means that the consumption by one person does not deplete the quantity of the good available for others. Non-excludability means non-payers cannot be excluded from consumption and leads to the free-rider problem. Free-riders are non-payers who 'free-ride' on the payment of others. Private firms are therefore unlikely to earn a profit providing such goods, and hence they are often provided by the government.

22