Question

1. For each of the examples below, please answer the following: (a) Does an externality exist? If so, classify the externality as posi- tive/negative (or both). (b) If an externality exists, determine whether the Coase theorem applies (c) If an externality exists and the Coase theorem does not apply, what can a government do? Consider the following examples: (a) British Petroleum drills for oil in the gulf coast (b) Your upstairs neighbors throwing loud party for the homecoming game. (c) Bringing crying babies on a plane (d) Coming to lecture with a cold.

Answer 1

a)

The externality does exist in society. The externalities are the negative or positive outcomes of consumption or production which are faced by third parties.

Thus, the externalities could be either positive or negative.

COVID-19 vaccination would have positive externalities.

b)

The Coase theorem is able to solve the problem of externalities when the property rights are clearly demarcated and there are no bargaining costs involved.

c)

The Coase theorem does not work where the free-rider problem exists and the bargaining cost is very high. here the government will get involved and seeks to establish the optimal equilibrium through the taxes or subsidies.

a)

Gulf Coast will deplete the oil reserve and environmental degradation occurs here, this is an example of negative externalities.

b)

Throwing the loudspeaker party would cause negative externalities to the families who reside in the neighbor.

c)

Crying baby makes the other co-passengers disturbed, thus, this is an example of negative externalities.

d)

Coming to the lecture with cold increases the chances of spread of virus, this an example of negative externalities.