CEA Environmental and Resource Economics 1 — Questions and Answers
Question 1: What is a 'negative externality' in environmental economics?
- A cost imposed on a third party not involved in the economic transaction (Correct answer)
- A tax that reduces production below the socially optimal level
- A market failure caused by asymmetric information
- A subsidy that distorts resource allocation toward polluters
Correct answer: A cost imposed on a third party not involved in the economic transaction
A negative externality occurs when a market transaction imposes costs on third parties, such as pollution from a factory harming nearby residents who bear health costs.
Question 2: The Coase Theorem states that externalities can be resolved efficiently through private negotiation when which condition holds?
- Property rights are well-defined and transaction costs are negligible (Correct answer)
- Government sets the correct Pigouvian tax rate
- The number of affected parties is large enough to form a coalition
- Markets are perfectly competitive with no public goods
Correct answer: Property rights are well-defined and transaction costs are negligible
The Coase Theorem holds that if property rights are clearly assigned and bargaining is costless, parties will negotiate to the socially efficient outcome regardless of initial rights allocation.
Question 3: A Pigouvian tax is designed to address market failures by doing which of the following?
- Setting a tax equal to the marginal external cost to internalize the externality (Correct answer)
- Taxing all output of a polluting industry at a flat rate
- Subsidizing clean alternatives to crowd out dirty production
- Capping total emissions and distributing permits by revenue
Correct answer: Setting a tax equal to the marginal external cost to internalize the externality
A Pigouvian tax corrects for negative externalities by raising the private cost of production to equal the full social cost, leading producers to internalize the harm they cause.
Question 4: What is the 'Tragedy of the Commons' as described by Garrett Hardin?
- Shared resources are overexploited because individual users ignore the cost imposed on others (Correct answer)
- Public goods are underprovided because of free-rider behavior
- Common property regimes always lead to market failure
- Governments overregulate common pool resources, reducing efficiency
Correct answer: Shared resources are overexploited because individual users ignore the cost imposed on others
The Tragedy of the Commons describes how individually rational users of a shared resource overexploit it, leading to collective ruin—classic examples include overfishing and groundwater depletion.
Question 5: In environmental economics, what does a 'cap-and-trade' system accomplish?
- Sets a total emissions limit and allows firms to buy and sell emission permits (Correct answer)
- Caps the price firms can charge for polluting and trades the surplus to government
- Sets uniform emission standards and taxes firms that exceed the cap
- Allows trading of carbon credits without any aggregate emissions ceiling
Correct answer: Sets a total emissions limit and allows firms to buy and sell emission permits
A cap-and-trade system establishes a binding ceiling on total emissions and lets firms with low abatement costs sell excess permits to firms with high abatement costs, achieving reductions at least cost.
Question 6: What distinguishes a 'public good' from a 'common pool resource' in environmental economics?
- Public goods are non-excludable and non-rival; common pool resources are non-excludable but rival (Correct answer)
- Public goods are rival and excludable; common pool resources are neither
- Common pool resources have higher free-rider problems than public goods
- Public goods are always provided by government; common pool resources are privately managed
Correct answer: Public goods are non-excludable and non-rival; common pool resources are non-excludable but rival
Public goods are both non-excludable (can't prevent use) and non-rival (one person's use doesn't reduce availability), while common pool resources are non-excludable but rival, making them subject to overuse.
CEA Environmental and Resource Economics 1
What is a 'negative externality' in environmental economics?