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1. What is an externality? Externalities are costs or benefits that affect third parties as a result of a transaction taking place despite that person not being involved in the transactions. Negative externalities are costs that

a. Are negative externalities reflected in market supply curves? Negative externalities are NOT reflected in the market supply curve.

b. Why or why not? Because the market supply curve is derived only from those who are directly involved in the transaction

2. Because taxes impose a cost on society, they create no benefit for society. Explain.(b)False. When there is a negative externality, the market is producing at a level that is greater than a socially-optimal output level. Taxes help raise the supply curve to a point that reduces output closer to a socially-optimal output level.

3. What is the difference between private costs and social costs? Private costs are only the costs that affect those directly involved in a transaction while social costs also factor in the external costs to the third parties.

4. When a large number of refrigerators are produced in a society, there are a number of negative spillovers (externalities): higher material waste from old products, increased damage to the ozone layer, happier residents.

a. Depict this on a supply and demand framework, showing the initial equilibrium price and quantity, and any inefficiency (dead-weight loss) due to social factors. SEE BELOW

b. Come up with an innovative government policy which can discourage use of traditional freon refrigerators? The government could create a tax such the the private marginal cost equals the social marginal cost.

c. What happens to the dead-weight loss and how can it get to a socially efficient quantity? When this happens, the dead-weight loss will be reduced because the output level will be closer to the socially-optimal level.

d. What condition is necessary to eliminate the entirety of the social inefficiency? In order to fully eliminate the inefficiency, the tax must be exactly equal to the external cost so that the marginal private cost and marginal social costs are equal.

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