Public Goods & Externalities worksheet
The answer key prints on its own page, so hand out everything before it.
Public Goods & Externalities: practice worksheet
1. A chemical plant dumps waste into a river, harming downstream fisheries. This is an example of:
- (A) A positive externality, because the plant creates jobs
- (B) A negative externality, because third parties bear uncompensated costs
- (C) A public good, because the river is non-excludable
- (D) The free-rider problem, because fishers are free-riding on the plant
2. When a positive externality exists, the market equilibrium quantity is:
- (A) Greater than the socially optimal quantity
- (B) Equal to the socially optimal quantity
- (C) Less than the socially optimal quantity
- (D) Indeterminate without more information
3. A Pigouvian tax on a good with a negative externality should be set equal to:
- (A) The total revenue the government wants to collect
- (B) The marginal private cost at equilibrium
- (C) The marginal external cost per unit
- (D) The market price minus the social cost
4. Which of the following is the best example of a public good?
- (A) A toll road with electronic payment
- (B) A Netflix subscription
- (C) National defense
- (D) A loaf of bread from a bakery
5. The free-rider problem explains why public goods are typically:
- (A) Overproduced by private markets
- (B) Underproduced or not produced by private markets
- (C) Produced efficiently by monopolies
- (D) Only consumed by wealthy individuals
6. According to the Coase theorem, private negotiation can resolve externalities efficiently when:
- (A) The government imposes a Pigouvian tax
- (B) Property rights are well-defined and transaction costs are low
- (C) There are many parties involved in the externality
- (D) The externality is positive rather than negative
7. If the marginal external cost of pollution is $20 per unit and the government imposes a $20 Pigouvian tax, the deadweight loss from the externality becomes:
- (A) Larger, because taxes always create deadweight loss
- (B) Zero, because the tax aligns private and social costs
- (C) $20 per unit of output
- (D) Unchanged, because taxes do not affect externalities
8. Vaccines generate significant positive externalities. Without government intervention, the market price of vaccines will be _____ and the quantity will be _____ compared to the social optimum.
- (A) Too high; too low
- (B) Too low; too high
- (C) Too high; too high
- (D) Too low; too low
9. A good that is non-rival but excludable is classified as a:
- (A) Public good
- (B) Private good
- (C) Club good
- (D) Common resource
10. Overgrazing on public pastureland is an example of the 'tragedy of the commons.' This occurs because the pastureland is:
- (A) Non-rival and non-excludable, like a public good
- (B) Rival and excludable, like a private good
- (C) Rival but non-excludable, so each herder has an incentive to overuse the resource
- (D) Non-rival but excludable, like a club good
Public Goods & Externalities: answer key
1. (B) The fisheries bear genuine costs (contaminated water, damaged catch) from production they were never part of. Negative externality by definition. (A) confuses the plant's employment with the pollution spillover; jobs are a private market outcome, not the externality at issue. (D) gets the relationship completely backwards; the fishers are victims of the pollution, not free-riders benefiting from the plant.
2. (C) Social benefit exceeds private benefit. Buyers weigh only their own gain, so they purchase less than society would want. Underproduction. (A) describes negative externalities, which is the overproduction case.
3. (C) The tax closes the gap between private and social cost. That gap is the external cost per unit, which is the vertical distance between the two supply curves on the graph. Set the tax equal to that distance and private cost jumps up to match social cost. (A) misidentifies the goal; it's allocative efficiency, not revenue maximization. (B) would double-count private costs the firm already pays.
4. (C) National defense is non-rival (protecting one citizen doesn't reduce protection for anyone else) and non-excludable (you can't selectively leave some citizens undefended). Toll roads are excludable because non-payers get blocked at the booth. Netflix is excludable through login credentials. Bread is both rival and excludable. Private good through and through.
5. (B) Non-excludability means people enjoy the benefit without paying for it. If enough people free-ride, no private firm can generate sufficient revenue to justify producing the good. It gets underproduced or skipped entirely. (A) describes the negative externality outcome, not the public good problem. (C) has no logical basis because monopoly power doesn't solve the excludability issue that drives the free-rider problem.
6. (B) Clear property rights plus low bargaining costs are the two conditions Coase requires. Parties negotiate their way to efficiency without government intervention. (A) is Pigou's approach, not Coase's. (C) actually undermines Coasean bargaining; more parties means higher transaction costs, which is exactly what causes the theorem to fail.
7. (B) Toggle the tax on the graph and the deadweight loss triangle disappears. The $20 tax shifts supply up by exactly the external cost, making private cost equal to social cost. The market equilibrium now sits at the socially optimal point. (A) applies to taxes on goods without externalities, because those create new distortions. A Pigouvian tax corrects an existing distortion rather than creating one.
8. (A) With a positive externality, marginal social benefit exceeds marginal private benefit. The market only reflects private benefit, settling at a price that's too high relative to social value (which prices out buyers who would generate genuine social gains) and a quantity that falls short of the optimum. A subsidy would lower the effective price and push quantity toward where society wants it. (B) describes the negative externality pattern, which is the reverse.
9. (C) A **club good** (also called a toll good) is non-rival up to a congestion point but excludable, so the provider can restrict access to paying members. HBO, a private golf course, a gated community pool. (A) requires both non-rivalry and non-excludability; excludability disqualifies it. (D) is the opposite combination: rival but non-excludable.
10. (C) Common resources are rival (one cow eating the grass leaves less for the next cow) but non-excludable (herders can't be fenced out of open pasture). Each herder captures the full private benefit of adding another cow but shares the overgrazing damage with everyone else. That lopsided incentive drives overuse even though collective restraint would make everyone better off, which is exactly what Garrett Hardin described in his 1968 essay. (A) is wrong because if the pasture were non-rival, overgrazing wouldn't be an issue in the first place.