William Rainey Harper College
ECO 211

Review: Lessons 5a and 5b

Market Failures and Benefit Cost Analysis

INSTRUCTION: Select the BEST answer for each question by marking the circle next to your selection, then click on the [Grade the Test] button at the bottom.

1.

In a competitive market:

A.

spillover benefits will always exceed spillover costs.

B.

resources will be misallocated if demand and supply are not properly adjusted by government for large spillover costs and benefits.

C.

resources will be allocated efficiently only if spillover benefits equal spillover costs.

D.

an efficient allocation of resources is always realized.



2.

A pure market economy overallocates resources to the production of goods which:

A.

involve spillover costs (external costs).

B.

involve spillover benefits (external benefits).

C.

are public goods.

D.

are inexpensive to produce.



3.

If an activity creates sizable external costs as well as private costs, then economic theory suggest the activity should be:

A.

left alone.

B.

prohibited by law.

C.

encouraged by subsidies.

D.

discouraged by taxes or regulation.



4.

If a market is competitive, the resulting equilibrium output:

A.

will also be the most efficient output.

B.

will always be less than the most efficient output.

C.

will always be greater than the most efficient output.

D.

may be either larger or smaller than the most efficient output.



5.

Benefit-cost analysis is attempts to:

A.

compare the real worth, rather than the market values, of various goods and services.

B.

compare the relative desirability of alternative distributions of income.

C.

determine whether it is better to cut government expenditures or reduce taxes.

D.

compare the benefits and costs associated with any economic project or activity.



6.

Answer the next question(s) on the basis of the following information for four highway programs of increasing scope. All figures are in millions of dollars.

Program

Total cost

Total benefit

A

$ 2

9

B

6

16

C

12

21

D

20

23

R-1 REF30015

The above data indicate that:

A.

there is no highway program which is economically justifiable on the basis of benefit-cost analysis.

B.

the marginal cost and marginal benefit of Program A are $2 and $9 respectively.

C.

the marginal cost and marginal benefit of Program C are $12 and $21 respectively.

D.

the marginal cost and marginal benefit of Program A cannot be determined.



7.

Answer the next question(s) on the basis of the following information for four highway programs of increasing scope. All figures are in millions of dollars.

Program

Total cost

Total benefit

A

$ 2

9

B

6

16

C

12

21

D

20

23

R-1 REF30015

On the basis of the above data we can say that:

A.

Program D is the most efficient on economic grounds.

B.

Program C is the most efficient on economic grounds.

C.

Program B is the most efficient on economic grounds.

D.

Program A is the most efficient on economic grounds.



8.

R-2 F30020

Refer to the above diagram in which S is the market supply curve and S t is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these external costs is large. Without government interference, this market will result in:

A.

an optimal allocation of society's resources.

B.

an underallocation of resources to this product.

C.

an overallocation of resources to this product.

D.

a higher price than is consistent with an optimal allocation of resources.



9.

R-2 F30020

Refer to the above diagram in which S is the market supply curve and S t is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these external costs is large. If the government wishes to establish an optimal allocation of resources in this market, it should:

A.

not intervene because the market outcome is optimal.

B.

subsidize consumers so that the market demand curve shifts leftward.

C.

subsidize producers so that the market supply curve shifts leftward (upward).

D.

tax producers so that the market supply curve shifts leftward (upward).



10.

R-3 F30022

Refer to the above diagrams for two separate product markets. Assume that society's optimal level of output in each market is Q0 and that government purposely shifts the market supply curve from S to S1 in diagram (a) and from S to S2 in diagram (b). We can conclude that the government is correcting for:

A.

spillover costs in diagram (a) and spillover benefits in diagram (b).

B.

spillover benefits in diagram (a) and spillover costs in diagram (a).

C.

spillover costs in both diagrams.

D.

spillover benefits in both diagrams.



11.

R-3 F30022

Refer to the above diagrams for two separate product markets. Assume that society's optimal level of output in each market is Q0 and that government purposely shifts the market supply curve from S to S1 in diagram (a) and from S to S2 in diagram (b). The shift of the supply curve from S to S1 in diagram (a) might be caused by a per unit:

A.

subsidy paid to the producers of this product.

B.

tax on the producers of this product.

C.

subsidy paid to the buyers of this product.

D.

tax on the buyers of this product.



12.

R-3 F30022

Refer to the above diagrams for two separate product markets. Assume that society's optimal level of output in each market is Q0 and that government purposely shifts the market supply curve from S to S1 in diagram (a) and from S to S2 in diagram (b). The shift of the supply curve from S to S2 in diagram (b) might be caused by a per unit:

A.

subsidy paid to the producers of this product.

B.

tax on the producers of this product.

C.

subsidy paid to the buyers of this product.

D.

tax on the buyers of this product.



13.

R-4 F30027

Refer to the above diagram of the market for product X. Curve S t embodies all costs (including spillovers) and Dt embodies all benefits (including spillovers) associated with the production and consumption of X. Assuming the equilibrium output is Q1, we can conclude that the existence of spillover:

A.

costs has resulted in an overallocation of resources to X.

B.

benefits has resulted in an overallocation of resources to X.

C.

costs has resulted in an underallocation of resources to X.

D.

benefits has resulted in an underallocation of resources to X.



14.

R-4 F30027

Refer to the above diagram of the market for product X. Curve S t embodies all costs (including spillovers) and Dt embodies all benefits (including spillovers) associated with the production and consumption of X. Assuming the equilibrium output is Q2, we can conclude that the existence of spillover:

A.

costs has resulted in an overallocation of resources to X.

B.

benefits has resulted in an overallocation of resources to X.

C.

costs has resulted in an underallocation of resources to X.

D.

benefits has resulted in an underallocation of resources to X.



15.

In a market for pollution rights an increase in demand would:

A.

raise the price of pollution rights, but leave the quantity unchanged.

B.

stimulate the economic incentive to pollute.

C.

increase the actual amount of pollution.

D.

induce an increase in the supply of pollution rights.



16.

Suppose that a large tree on Shawn's property is blocking Sam's view of the lake below. Shawn accepts Sam's offer to pay Shawn $100 for the right to cut down the tree. This situation describes:

A.

the Coase theorem.

B.

the diamond-water paradox.

C.

logrolling.

D.

a market for externality rights.



17.

Which of the following is most likely to be accompanied by external or spillover benefits?

A.

the construction of a nuclear power plant

B.

studying in the library

C.

eating dinner at an expensive French restaurant

D.

being immunized for measles



18.

A subsidy:

A.

should be provided when there are external costs.

B.

should be provided when there are external benefits.

C.

should be provided only when a public good is being produced.

D.

is appropriate when firms are guilty of pollution.



19.

The market system fails to produce public goods because:

A.

there is no need or demand for such goods.

B.

private firms cannot restrict the benefits of such goods to consumers who are willing to pay for them.

C.

public enterprises can produce such goods at lower cost than can private enterprises.

D.

their production seriously distorts the distribution of income.



20.

Which of the following is an example of a public good:

A.

a fireworks display

B.

a hotdog.

C.

a personal computer.

D.

a barbeque grill.




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