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Unformatted text preview: CHAPTER 20 EXTERNALITIES AND PUBLIC GOODS The problems in this chapter illustrate how externalities in consumption or production can affect the optimal allocation of resources and, in some cases, describe the remedial action that may be appropriate. Many of the problems have specific, numerical solutions, but a few (20.4 and 20.5) are essay-type questions that require extended discussion and, perhaps, some independent research. Because the problems in the chapter are intended to be illustrative of the basic concepts introduced, many of the simpler ones may not do full justice to the specific situation being described. One particular conceptual shortcoming that characterizes most of the problems is that they do not incorporate any behavioral theory of governmentthat is, they implicitly assume that governments will undertake the efficient solution (i.e., a Pigovian tax) when it is called for. In discussion, students might be asked whether that is a reasonable assumption and how the theory might be modified to take actual government incentives into account. Some of the material in Chapter 20 might serve as additional background to such a discussion. Comments on Problems 20.1 An example of a Pigovian tax on output. Instructors may wish to supplement this with a discussion of alternative ways to bring about the socially optimal reduction in output. 20.2 A simple example of the externalities involved in the use of a common resource. The allocational problem arises because average (rather than marginal) productivities are equated on the two lakes. Although an optimal taxation approach is examined in the problem, students might be asked to investigate whether private ownership of Lake X would achieve the same result. 20.3 Another example of externalities inherent in a common resource. This question poses a nice introduction to discussing compulsory unitization rules for oil fields and, more generally, for discussing issues in the markets allocation of energy resources. 20.4 This is a descriptive problem involving externalities, now in relation to product liability law. For a fairly complete analysis of many of the legal issues posed here, see S. Shavell, Economic Analysis of Accident Law . 20.5 This is another discussion question that asks students to think about the relationship between various types of externalities and the choice of contract type. The Cheung article on sharecropping listed in the Suggested Readings for Chapter 20 provides a useful analysis of some of the issues involved in this question.analysis of some of the issues involved in this question....
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