1. Explain concisely what the free rider problem is and what experiments show ab
ID: 1219060 • Letter: 1
Question
1. Explain concisely what the free rider problem is and what experiments show about how subjects behave in setting where they have to contribute to the provision of a common (or public) good.
2. The Great Salt Lake in Utah is quite clean compared to the Mediterranean Sea in Europe. Take a look at both seas in a map and use the concept of externalities to explain why.
3. The government is interested in reducing the pollution generated at several factories. One problem is that it is unknown how easy or hard it is for these factories to achieve that goal (Their marginal cost of pollution reduction is uncertain) In this setting, is it better to use an emissions fee or cap and trade approach? Explain why. Assume also that the marginal benefit of pollution reduction is believed to be highly inelastic.
4. Two firms (X and Y) generate 20 units of pollution each. X has a Marginal cost of pollution reduction given by 2*q (q is the quantity of pollution reduction) and Y has 4*q. The government wants the total reduction in pollution to be 15 units. What emissions fee should it choose to achieve that goal? What is the tax bill for each firm?
Explanation / Answer
1. The goods that does not belong to one person only who has paid for it. Even non-payers enjoy the benefit of such goods at zero cost. Such goods are referred to as public goods. Ex: Street hoardings are watched by a large number of people. Its use cannot be limited to one person only restricting others to watch it. In the study of economics, it is called 'free rider problem' as it is impossible to exclude individuals from its usage.
In other words, we can say that a free rider problem occurs when some people or public in population either have consumption more than their fair share of a common goods & services or resources or pay less than their fair share of the cost of that common goods & services or resources.
2. Externality implies to the benefit or cost suffered by the third party. Usually, the third party is considered society. The more of a commodity is produced, the more an externality occurs. It can be positive as well as negative. Both the externalities affect the market sector of that commodity consumed or produced. For example: a firm producing chemicals that emits air pollutants, in other words, causes pollution. Due to which, a nearby lake also get polluted, which makes all the aquatic animals, like fish die. This is a loss for all the fishermen, resulting in loss of their income. This will be a negative externality.
Here, in this case there is comparison between The Great Salt Lake in Utah and the Mediterranean Sea in Europe. Both the water bodies cause pollution. There is a pollution problem from industrial as well as urban areas in Great Salt Lake. However, pollution is tremendously high in Mediterranean Sea in Europe. Many of the aquatic species have died because of the pollution in the sea. The discharge of chemical waste leads to marine pollution. Moreover, tourism industry have also affected the marine environment by causing garbage disposal near the coast and also disturbing marine habitats. Overfishing has also affected marine habitat as many species have got disappeared causing disturbance in ecological balance. This has caused negative impact on marine life.
3. Emission of chemicals disturbs aquatic life and marine species start getting disappear causing a great loss to the fishermen and their occupation. This will affect the demand and supply in the market causing inefficiency in the market. This causes market failure. Seeing, this the government imposes taxes on such firms. There will be regulations and legislations introduced. Imposition of taxes addresses such situations effectively and efficiently. This brings back the efficiency in the market as well as society, due to which demand gets equivalent to the supply. Tax will be imposed on polluters. Permits to pollute at certain level without disturbing air atmosphere will be sold.
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