REVIEW QUESTIONS 1. Explain why externalities prevent the attainment of efficiency when goods are traded in competitive markets. 2. Do you agree with the following statement? “Effi-ciency cannot be achieved when externalities exist.” Explain your view. 3. Why do prices fail to represent the opportunity costs of resources when externalities exist? 4. How can a corrective tax adjust costs to reflect externalities? What effects will a corrective tax have on prices, output, and pollution? 5. Suppose a positive externality is associated with col-lege enrollment. Assume that college instruction is sold in a competitive market and that the marginal social cost of providing it increases with enrollment. Show how a corrective subsidy to college students will increase the market price of instruction. Show
the net gain in well-being possible from the subsidy and the amount of tax revenue required to finance its costs on your graph. 6. What kinds of information must be gathered to internalize an externality? 7. Why do limits on pollution emissions fail to inter-nalize the externality that generates the pollution? 8. Under what conditions are externalities likely to be internalized without the necessity of government intervention? 9. Why might it be argued that the distinction between emitters and receptors of an externality involves an arbitrary judgment? 10. What criteria can be used to determine if a small-number externality exists? Why is it undesirable to compensate receptors of external damage in cases where there are few emitters and many receptors?