Externality Theory & Public goods

Please read the slides before writing the answers. As much as possible, please use your own language, and if you borrow language from the lecture slides, please provide the reference in your submission.

Answer the following questions:

1. (a) In the context of externalities, clearly differentiate between private costs and benefits, and social costs and benefits. Provide any equations which may be relevant in this answer. (4 points)

(b) With the help of a graph, clearly explain how a negative production externality could lead to a both a deadweight loss and an overproduction of the good in society. (4 points)

(c) Why is it that in a negative production externality, SMB = PMB? (2 points)

2. (a) What do we mean by internalizing an externality? (2 points)

(b) Clearly define the two different parts of the Coase Theorem. (4 points)

(c) Describe two real-life problems with Coasian solutions. (4 points)

3. With the help of a graph, explain how a public sector remedy in the form of subsidy can solve the problem of under-production in the case of a positive production externality. (4 points)

4. (a) Clearly explain with the help of equations, how the optimality conditions for the optimal provision of private goods differ from that for public goods? (3 points)

(b) What is the free-rider problem in the context of public goods? State two situations/cases in which the private sector could potentially solve or reduce this problem. (4 points)

5. (a) What do we mean when we say that public education could crowd out private schooling? (3 points)

(b) What is a potential public-sector solution to this above crowding out problem? Could this solution lead to further problems for society? (6 points)

• • Length of answers – is completely up to you but the questions need to answered as completely as possible. Longer answers will never be penalized!
  • Please number your answers according to the numbering of the questions provided above