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Economics 101 Practice Test: Externalities

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In economics, an externality is a cost or benefit that affects a third party that is not directly involved in the activity that caused it. Externalities can be positive or negative. Externalities can be considered as unpriced components in consumer or producer market transactions. They can be tiny, but when they are large they can become problematic. Externalities are one of the main reasons governments intervene in the economic sphere. There are four main types of externalities: positive production, positive consumption, negative production, and negative consumption. Here are some... Show more

In economics, an externality is a cost or benefit that affects a third party that is not directly involved in the activity that caused it. Externalities can be positive or negative.

Externalities can be considered as unpriced components in consumer or producer market transactions. They can be tiny, but when they are large they can become problematic. Externalities are one of the main reasons governments intervene in the economic sphere.

There are four main types of externalities: positive production, positive consumption, negative production, and negative consumption.

Here are some examples of externalities:
Negative externality: Erosion and chemical runoff caused by building roads, which causes water pollution further downstream
Positive externality: Construction of a flyover or a highway reduces transport cost and journey time of its users

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Economics 101 Practice Test: Externalities

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1. When a market experiences a positive consumption externality,

the demand curve does not reflect the value to society of the good.the private value is greater than the social value.too much of the good is being produced.the government can internalize the externality by imposing a tax on the product.

2. A positive consumption externality occurs when

Jack receives a benefit from John’s consumption of a certain good.Jack’s consumption is not beneficial to John.Jack’s benefit exceeds John’s benefit when they each consume the same good.Jack receives personal benefits from his own consumption of a certain good.

3. The Coase theorem suggests that private markets may not be able to solve the problem of externalities

when market participants do not want the externality to be eliminated.when the number of interested parties is large and costs are high.if government does not become actively involved in the process.if the firm in the market is a monopoly.

4. The government can internalize a positive production externality by

subsidizing production which would increase supply.subsidizing production which would decrease supply.taxing production which would decrease supply.taxing production which would increase supply.

5. When one firm sells its pollution permit to another firm, each of the following will occur EXCEPT

the total amount of pollution remains the same.social welfare is enhanced.government revenue increases.both firms benefit.

6. Firms that are involved in different types of business could be evidence of an attempt to

increase private profit at the expense of consumers.reduce the impact of government regulation on their business.internalize some forms of positive externalities.increase the marginal external cost of production.

7. Internalizing a positive production externality through a government subsidy will cause industry supply to

decrease by an amount greater than the subsidy.increase by an amount less than the subsidy.increase by an amount equal to the subsidy.remain unchanged.

8. Externalities occur when

higher wages result in increased spending.the government imposes taxes.one person’s actions affect the well-being of a bystander.increases in the price of oil cause gasoline prices to rise.

9. Internalizing an externality refers to

the fact that sellers only consider their private costs when making a decision.government establishing agencies such as the Environmental Protection Agency to enforce regulations.the fact that buyers only consider their private benefits when making a decision.altering incentives so people consider the external effects of their actions when making a decision.

10. Emission controls on automobiles is an example of a

policy to reduce congestion on urban freeways.policy that reduces pollution by allocating resources through market mechanisms.command-and-control policy to increase social efficiency.Pigovian tax on automobiles, based on how much they pollute.

11. All remedies for externalities share the goal of

moving the allocation of resources toward the market equilibrium.increasing the allocation of resources.moving the allocation of resources toward the social optimum.decreasing the allocation of resources.

12. A negative consumption externality will cause a private market to produce

less than is market optimal.less than is socially desirable.more than is socially desirable.the socially desirable quantity.

13. society could benefit from

an increase in the production of this product.the government not interfering in the market for this product.the government placing a Pigovian tax on this product.a decrease in the production of this product.

14. When action is taken to remedy externalities, the goal is to

hold the government accountable for eliminating these market failures.increase total production in the economy.move the allocation of resources closer to the social optimum.eliminate the externalities without affecting market outcomes.

15. Which of the following policies is government most inclined to use when faced with a positive externality?

taxationsubsidiesusage feespermits

16. Private markets fail to account for externalities because

decision makers in the market fail to take into account the external effects of their behavior.the government can easily correct any adverse effect externalities may have on the market.sellers include any costs associated with externalities in the price of their product.externalities don’t occur in private markets.

17. A Pigovian tax is a tax

that special interest groups lobby for in order to decrease the cost of producing goods and services.on pollution regulations.that will move the market away from the optimum quantity.that is enacted to correct the effects of a negative externality.

18. Technology spillover means that

it is the government’s responsibility to subsidize firms which are engaged in high-tech research.a firm’s research yields technological knowledge that can then be used by society as a whole.when firms invest in the latest production technology, the cost of that technology ‘spills over’ to the prices consumers must pay for the product.those firms engaged in technology research may be taxed by the government if that research causes negative externalities in the market.

19. To enhance the well-being of society, a social planner will encourage firms to increase production when

the firms are producing basic goods.there is excess supply in the market.negative externalities associated with production are imposed only upon consumers.technology spillovers are associated with production.

20. A comparison between a Pigovian tax and tradable pollution permits shows that

a Pigovian tax fixes the acceptable pollution quantity where pollution permits allow for increases in pollution levels.both policies will effectively eliminate a positive externality in a market.levying a Pigovian tax is always preferable to issuing pollution permits.a Pigovian tax sets the price of pollution where pollution permits set the quantity of pollution.

21. Internalizing a negative production externality will cause the supply curve faced by an industry to

remain unchanged.shift either right or left, depending on the industry.shift to the right.shift to the left.

22. When a market experiences a positive production externality, we can expect a

greater market output and higher market price than optimal.smaller market output and lower market price than optimal.greater market output and lower market price than optimal.smaller market output and a higher market price than optimal.

23. An optimal tax on pollution (a negative production externality) would be one in which

the value to consumers at market equilibrium exceeds the cost of production (including tax).producers choose not to produce any pollution.a benevolent social planner is able to maximize production.producers internalize the cost of the pollution.

24. Which of the following is NOT true concerning tradable pollution permits?

Tradable pollution permits can be traded in a market governed by supply and demand.Tradable pollution permits will be sold by firms that can reduce pollution at low costs.Tradable pollution permits are a scarce resource.Tradable pollution permits eventually lead to an efficient elimination of all pollution.

25. Which of the following is true of the Coase theorem ?

Interested parties will need an arbitrator in order to reach an agreement that is efficient.Interested parties can reach an outcome in which everyone is better off.The bargain outcome will be inefficient.Government intervention is necessary to solve the problem of externalities.

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