Question
Consider the market for cement production. Suppose that cement production emits a cloud that causes breathing problems for people that live in the neighborhood, thus creating health problems for by-standers. With that in mind, answer the following questions.
a) (4 pts) Do the cement industry have a negative or a positive externality? Is it an externality in production or in consumption?
b) (5 pts) Describe how the externality affects the private market for cement. Make sure your discussion uses p*& q* to indicate the private market equilibrium price and quantity, and a pE & qE to indicate the socially optimal price and quantity.
c) (3 pts) Given this externality, list the three things that the government can do to get the private market closer to the socially optimal outcome.
d) (3 pts) Which of the three things you listed in part c is the best way for the government to increase society’s welfare? Explain why.
e) (2 pts) Describe Coase Bargaining by defining the Coase Theorem.
f) (2 pts) Now suppose that the benefit of cement production for the firm is B = $100,000 and the cost to the local community in health related expenses is $95,000. Should the cement be produced? Explain.
g) (2 pts) If the Coase Theorem were applied to this situation, what would be the outcome? Describe how this outcome could be achieved.
h) (3 pts) List the three things that will prevent Coase Bargaining from working.
Explanation / Answer
a) (4 pts) Do the cement industry have a negative or a positive externality? Is it an externality in production or in consumption? The cement industry has negative externality in production because the production causes an external harm. b) (5 pts) Describe how the externality affects the private market for cement. Make sure your discussion uses p*& q* to indicate the private market equilibrium price and quantity, and a pE & qE to indicate the socially optimal price and quantity. The negative externality implies that p* qE. That is, a private equilibrium will have "too low" of prices and "too high" of quantities because it does not account for the external cost to society. c) (3 pts) Given this externality, list the three things that the government can do to get the private market closer to the socially optimal outcome. The government can tax producers of cement; it can subsidize the bystanders; or it can impose a quota on cement. d) (3 pts) Which of the three things you listed in part c is the best way for the government to increase society’s welfare? Explain why. The tax on concrete is probably the best because it produces less deadweight loss than the quota, generates tax revenue, doesn't have to be funded, and is easier to do. e) (2 pts) Describe Coase Bargaining by defining the Coase Theorem. Coasean bargaining means that we assign property rights to "clean air." If the bystanders have property rights, then the cement producers must pay them for the right to produce cement. If the producers have rights, then the bystanders must pay the producers to forgo production. f) (2 pts) Now suppose that the benefit of cement production for the firm is B = $100,000 and the cost to the local community in health related expenses is $95,000. Should the cement be produced? Explain. Yes because the net benefit is positive. 100000 - 95000 = $5000. g) (2 pts) If the Coase Theorem were applied to this situation, what would be the outcome? Describe how this outcome could be achieved. The outcome would be that the firm would pay the local community $95000 for the right to produce cement and still make a $5000 profit. Alternatively, society could pay the cement producer $100000 to not produce cement. h) (3 pts) List the three things that will prevent Coase Bargaining from working. (1) Can't identify the producers or the proportional cost created by each producer. (2) Can't identify who is harmed by the externality or their proportional harm. (3) Measure the amount of the harm or facilitate a transfer from the benefited to the harmed.