Chp 18 Instructor Manual

Chp 18 Instructor Manual - Chapter 18 GOVERNMENT IN THE...

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Chapter 18 GOVERNMENT IN THE MARKET ECONOMY QUESTIONS Q18.1 Air pollution costs the U. S. billions of dollars per year in worker absenteeism, healthcare, pain and suffering, and loss of life. Discuss some of the costs and benefits of a Pigou tax on air pollution. Q18.1 ANSWER Proponents of Pigou taxes argue that they can improve the allocation of resources by forcing producers and consumers to pay the full costs of production. Advocates of such taxes sometimes go further and argue that revenues from Pigou taxes could be used to finance a reduction in income tax rates. This idea is sometimes called the double-dividend hypothesis because under this scenario Pigou taxes increase efficiency in markets confounded with externalities and in other competitive markets that could then be unburdened by the reduction in income taxes. Critics view such arguments with caution. To see why, remember that Pigou taxes drive up the prices of goods and services that create pollution. The resulting increase in prices reduces consumer buying power because a given dollar amount buys fewer goods and services. In a sense, Pigou taxes are like a tax on consumption. If the labor market is already distorted because of an income tax, as is the case in the United States, a Pigou tax has the potential to increase the amount of distortion. In some cases, distortions in labor and other markets can outweigh the gains from Pigou taxes that correct negative externalities. Q18.2 What role does the price elasticity of demand play in determining the short-run effects of regulations that increase fixed costs? What if they lead to increased variable costs? Q18.2 ANSWER For a profit maximizing firm, a change in fixed costs does not alter the optimal short- run price/output combination. Price elasticity is irrelevant for determining the short- run effects of regulation that leads to increased fixed costs. When regulation increases variable costs, however, the profit maximizing price/output level will change. In this case, the price elasticity of demand determines whether the firm or the consumer will bear the added costs. The greater the elasticity of demand, the smaller the portion of increased costs the firm can pass onto consumers.
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56 Chapter 18 Q18.3 What is the essential difference between public and private goods? Give some examples of each and some examples of goods and services that involve elements of both. Q18.3 ANSWER If the consumption of a product by one individual does not reduce the amount available for others, the product is referred to as a public good. Once public goods are provided for a single consumer, they become available to all consumers at no additional marginal cost. Classic examples of public goods provided by various levels of government include national defense, police and fire protection. Over-the-air radio and TV broadcasts are typical examples of public goods provided
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This note was uploaded on 03/08/2011 for the course ECONABA 635 taught by Professor Leiter during the Summer '10 term at Andrew Jackson.

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Chp 18 Instructor Manual - Chapter 18 GOVERNMENT IN THE...

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