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1. The term ____________ refers to a market exchange that affects a third party who is outside or external to the exchange.


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Chapter 12     (Answers highlighted in YELLOW)

Multiple Choice Questions


1. The term ____________ refers to a market exchange that affects a third party who is outside or external to the exchange.

A. social costs

B. spillover

C. market failure

D. private costs


2. Market failure describes a situation in which the market  itself ______________________ in a way that balances social costs and benefits.

A. remains outside the transaction

B. incurs the costs outside the production process

C. fails to allocate resources efficiently

D. avoids externalities


3. The problem of pollution typically arises in ______________ economies around the world.   

A. high-income

B. low-income

C. high or low-income

D. middle income


4. In addition to the current levels of air and water pollution, a list of important environmental issues would most likely include: 

A. emissions of greenhouse gases 

B. safe disposal of hazardous waste materials

C. destruction of wetlands and other habitats

D. extinction of species and all of the above


5. If an externality of pollution exists for all manufacturers in a given industry, then all related social costs

A. are no longer represented in their supply curves.

B. continue to be represented in their supply curves.

C. are no longer represented in their demand curves.

D. continue to be represented in their demand curves.


6. In the U.S., the command-and-control environmental laws of the early 1970s, together with the ensuing amendments and updates that have been made to them over time, 

A. were necessary as US industries had zero incentive to control pollution.

B. were an inexpensive incentive for industrial polluters to improve performance.

C. are given considerable credit for cleaner air and water in recent decades.

D. draws distinctions between the needs of firms and costly equipment upgrades.


7. A pollution charge gives the trucking industry an incentive to reduce its emissions, as long as the _____________ of reducing the emissions is _______________ .

A. total cost; less than the tax

B. total cost; equal to the social cost

C. marginal cost; less than the tax

D. marginal cost; equal to the social cost


8. Certain schools of economic thought suggest that a _____________ would reduce pollution in a  __________________, when compared to command-and-control regulation.

A. marketable permit; less cost-effective way

B. pollution tax; flexible, more cost-effective way

C. marketable permit; less flexible manner

D. pollution tax; less cost effective, but flexible way


9. Environmentalist groups tend to prefer ________________ to ___________________. 

A. command-and-control regulations; marketable permits

B. marketable permits; pollution charges

C. pollution taxes; marketable permits

D. marketable permits; monetary refunds


10. Marketable permits can be viewed as a form of improved _______________.

A. command-and-control regulations

B. property rights

C. refundable tax credits

D. flat fee pollution tax


11. With respect to the benefits of clean air and water, which of the following would most likely be classified as being relatively easy to value in economic terms?

A. gains in farming, fishing and tourism

B. gains from lower levels of corrosion 

C. gains in environmental enjoyment 

D. all of the above are correct answers


12. The challenge of preserving biodiversity,


A. any nation itself can reduce emissions to solve global warming.

B. any nation acting alone can protect biodiversity around the world.

C. includes the full spectrum of animal and plant genetic material.

D. a nation can protect biodiversity within its own borders and c.


13. The supply and demand conditions facing a firm that makes widgets and generates a negative externality by dumping a highly toxic sludge in a nearby river is given in the table below.



Quantity Demanded

Quantity Supplied without Paying Social Costs

Quantity Supplied after Paying Social Costs


























The equilibrium price and quantity when only private costs are taken into account are

A. Price = $55, Quantity = 30

B. Price = $40, Quantity = 55

C. Price = $30, Quantity = 20

D. Price = $30, Quantity = 80


14. Michigan (MI) and Wisconsin (WI) both border Lake Michigan. Both states pollute Lake Michigan and both states suffer the consequences of the pollution. However, the two states face a prisoner’s dilemma of the sort studied in Chapter 12. Each country must decide whether to protect or not to protect Lake Michigan from pollution. The payoffs from the choices are shown in the table below. 







Not Protect




WI gains 500

MI gains 500

WI loses 300

MI gains 600

Not Protect

WI gains 600

MI loses 300

WI loses 250

MI loses 250

From the table, we know that if Wisconsin chooses to protect the lake, Michigan will choose to ______ the lake.   If Wisconsin chooses to not protect the lake, Michigan will choose to ______ the lake

A. protect, protect

B. not protect, protect

C. protect, not protect

D. not protect, not protect


15. Bulgaria primarily produces two goods, nesting dolls and grapes. The production of both goods primarily requires labor. The following table shows possible combinations of nesting dolls and grapes. 


Nesting Dolls

(measured in thousands)

Bushels of Grapes

(measured in thousands)
















Which of the following points is more likely to represent a market-oriented policy?

A. E

B. C

C. all points

D. none


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