Exercise 12.

1
If the equilibrium quantity is less than the
socially optimal quantity, one can infer that

A)
the supply curve for the activity is
below the socially optimal supply curve.

B)
the demand curve for the activity is
above the socially optimal demand.

C)
the production of this good has a
positive externality.

D)
the production of this good has a
negative externality.

E)
firm are not maximizing profits.
1

Answers to Exercise 12.1

The correct answer is (C).
When there is positive externality, the
external benefits enjoy by outsides
make the society prefer to have a larger
quantity of output.
But the market equilibrium quantity will
not consider this external benefit and
will produce a smaller quantity.
2

Exercise 12.2
Assume that reading economics produces a
positive externality. It will be the case that the
__________ than the socially optimal amount.

A)
supply curve for reading will be greater

B)
price of reading will be greater

C)
supply curve for reading will be less

D)
demand curve for reading will be
greater

E)
demand curve for reading will be less
3

Answers to Exercise 12.2

The correct answer is (E).
With positive externality, there is
external benefit and the marginal social
benefit exceeds marginal private
benefit.
The demand curve for reading is
marginal private benefit will be less than
the social optimal amount.
4

Exercise 12.3
Suppose coal mining produces a negative
externality in the form of polluted streams.
One can deduce that the unregulated

A) price of coal is too high.

B) quantity is too small.

C) quantity is too large.

D) supply curve is lower than the

regulated supply curve.

E) demand curve is higher than the

regulated demand curve.
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Answers to Exercise 12.3

The correct answer is (C).
Producers will ignore the external cost
and produces where MPC = MPB.
The society as a whole incur a higher
cost and prefer a smaller quantity of
output.
Thus the market quantity is too large
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Negative Externality

Point A is market outcome

Point B is social optimal outcome
MSC

Price
B

MPC

P2
P1

MSB=MPB

Q1

Q2

Quantity

Exercise 12.4
After correcting an externality, the
equilibrium price and quantity both rose.
What type of externality is this and what
are the likely actions that are
implemented to correct this externality?

Answers to Exercise 12.4

This is a positive externality.
When there is external benefit, the marginal social
benefit exceeds marginal private benefit.
The marginal social cost intersects the marginal
social benefit at a larger quantity and a higher
price compared to the market outcome.
When the positive externality is corrected, both
price and quantity rise.
The action needed is a government subsidy to
increase the marginal private benefit to be the
same as marginal social benefit.
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Exercise 12.5
Consider the benefit and cost of industrial
production, is the ideal amount of
pollution equals zero? Explain.

10

Answers to Exercise 12.5

The ideal amount of pollution is not zero
but the amount where marginal social
benefit equals marginal social cost.
Production of goods and services are
beneficial to society but bound to create
some pollution. So long as the benefits of
having output exceeds the cost of
pollution it is efficient to have a small
amount of pollution
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