Below are thirteen concepts, 1-13, and thirteen definitions, A-M. Match each definition to its concept by writing the correct letter in the extreme left-hand margin.

____ 1. Private cost

____ 2. External cost

____ 3. Social cost

____ 4. Externalities

____ 5. Social surplus

____ 6. Efficient equilibrium

____ 7. Efficient quantity

____ 8. Pigouvian tax

____ 9. External benefit

____ 10. Pigouvian subsidy

____ 11. Internalizing an externality

____ 12. Transaction costs

____ 13. Coase theorem

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A All the costs necessary to reach an agreement

B The cost to everyone: the private cost plus the external cost

C A cost paid by people other than the consumer or the producer trading in the market

D A tax on a good with external costs

E A benefit received by people other than the consumers or producers trading in the market

F A subsidy on a good with external benefits

G If transaction costs are low and property rights are clearly defined, private bargains will ensure that the market equilibrium is efficient even when there are externalities

H External costs or external benefits that fall on bystanders

I Consumer surplus plus producer surplus plus everyone else's surplus

J A cost paid by the consumer or the producer

K The price and quantity that maximizes social surplus

L The quantity that maximizes social surplus

M Adjusting incentives so that decision makers take into account all the benefits and costs of their actions, private and social

Question 2

1. A negative externality/an external cost exists when

A private cost exceeds social cost

B social cost exceeds private cost

2. If producing another ton of steel generates more air pollution (a negative externality), most economists would say a free market leads to

A the overproduction of steel

B the underproduction of steel

3. If producing another ton of steel generates more air pollution (a negative externality), economic efficiency would in principle be improved by

A imposing the appropriate tax on producers so that output falls

B imposing the appropriate tax on producers so that output rises

C providing the appropriate subsidy to producers so that output falls

D providing the appropriate subsidy to producers so that output rises

4. If theconsumption of another unit of a good generates more of a negative externality, economic efficiency would in principle be improved by

A imposing the appropriate tax on producers

B providing the appropriate subsidy to producers

C neither A nor B since the question assumes that consumption, not production, generates a negative externality

Questions 5-8test your understanding of the economics of positive externalities/external benefits, and of Pigouvian taxes and subsidies.

5. A positive externality/an external benefit exists when

A private benefit exceeds social benefit

B social benefit exceeds private benefit

6. If cultivating a flower garden for another hour generates a more beautiful display for passers-by (a positive externality), most economists would say a free market leads to the gardener spending

A too little time gardening

B too much time gardening

7. If cultivating a flower garden for another hour generates a more beautiful display for passers-by (a positive externality), economic efficiency would in principle be improved by

A imposing the appropriate tax on the gardener so that he spends less time gardening

B imposing the appropriate tax on the gardener so that he spends more time gardening

C providing the appropriate subsidy to the gardener so that he spends less time gardening

D providing the appropriate subsidy to the gardener so that he spends more time gardening

8. If theconsumptionof another unit of a good generates more of a positive externality, economic efficiency would in principle be improved by

A imposing the appropriate tax on producers

B providing the appropriate subsidy to producers

C neither A nor B since the question assumes that consumption, not production, generates a positive externality

Questions 9-10test your understanding of the Coase Theorem.

9. Which statement below is TRUE?

A The higher are transaction costs, the less likely that externalities would be eliminated through negotiation among interested parties.

B The lower are transaction costs, the less likely that externalities would be eliminated through negotiation among interested parties.

10. Which statement below is TRUE?

A The less clearly defined are property rights, the less likely that externalities would be eliminated through negotiation among interested parties.

B The more clearly defined are property rights, the less likely that externalities would be eliminated through negotiation among interested parties.

Question 11tests your understanding of the concept ofinternalizing externalities.

11. We might internalize externalities by (chooseone or more)

A allowing mergers between firms

B making ownership rights explicit

C promoting the emergence of markets

D recognizing and enforcing rules regarding the use of common property resources