AP_Krugman_Textbook

730 section 14 Market Failure and the Role of Government

Tackle the Test: Multiple-Choice Questions

1. The socially optimal level of pollution is
   a. less than that created by the market, but not zero.
   b. more than that created by the market.
   c. whatever the market creates.
   d. determined by firms.
   e. zero.


2. Which of the following is a source of negative externalities?
   a. loud conversations in a library
   b. smokestack scrubbers
   c. a beautiful view
   d. national defense
   e. a decision to purchase dressy but uncomfortable shoes.


3. Inefficiencies created by externalities can be dealt with through
   a. government actions only.
   b. private actions only.
   c. market outcomes only.
   d. either private or government actions.
   e. neither private nor government actions.
   4. The Coase theorem asserts that, under the right circumstances,
   inefficiencies created by externalities can be dealt with through
   a. lawsuits.
   b. private bargaining.
   c. vigilante actions.
   d. government policies.
   e. mediation.
   5. Which of the following makes it more likely that private
   solutions to externality problems will succeed?
   a. high transaction costs
   b. high prices for legal services
   c. delays in the bargaining process
   d. a small number of affected parties
   e. loosely defined legal rights

Tackle the Test: Free-Response Questions

1. Draw a correctly labeled graph showing the market-determined
   quantity of pollution, and explain why that quantity will be
   chosen in the absence of intervention and private deals. On
   the same graph, show the socially optimal level of pollution.

Answer (6 points)

MSC of

pollution

MSB of

pollution

QQPT QMKT

Quantity of pollution

Marginal social
cost, marginal
social benefit

1 point:The vertical axis is labeled “Marginal social cost, marginal social

benefit” or “Dollars per unit” and the horizontal axis is labeled “Quantity of

pollution” or “Q.”

1 point:The marginal social cost curve is labeled and upward sloping.

1 point:The marginal social benefit curve is labeled and downward sloping.

1 point:The market-determined level of pollution is shown on the horizontal

axis where the marginal social benefit curve reaches the horizontal axis.

1 point:In the absence of intervention and private deals, the marginal cost to

a polluter of polluting is zero. Thus, pollution will continue until the marginal

social benefit (all of which goes to the polluter) equals the polluter’s marginal

cost of zero, which occurs at the horizontal intercept of the marginal social

cost curve.

1 point:The socially optimal level of pollution is shown on the horizontal axis

below the intersection of MSCand MSB.

2. a. Define the marginal social cost of pollution.
   b. Define the marginal social benefit of pollution, and
   explain why polluting more can provide benefits to a firm
   even when it could produce the same quantity of output
   without polluting as much.
   c. Define the socially optimal level of pollution.