AP Microeconomics : Effect on Socially Optimum Levels

Study concepts, example questions & explanations for AP Microeconomics

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Example Questions

Example Question #1 : Effect On Socially Optimum Levels

Which government policy is typically used to correct a negative externality?

Possible Answers:

None of these answers

A decrease in the sales tax of a good

A law mandating the purchase of a good

Distributing a limited number of licenses to produce a good

A subsidy for the purchase of a good

Correct answer:

Distributing a limited number of licenses to produce a good

Explanation:

When the government issues a limited number of licenses to produce a good, it typically aims to reduce the production of that good. This is usually due to some form of negative externality associated with the production of that good. The other actions tend to increase the production or consumption of a good, which are usually designed when there is a positive externality associated. 

Example Question #1 : Effect On Socially Optimum Levels

In the absence of some public or private intervention, public goods will ____________ .

Possible Answers:

not be produced at all.

be overproduced relative to the socially optimum level.

None of these are correct.

be priced higher than at the optimal equilibrium point.

be underproduced relative to the socially optimum level.

Correct answer:

be underproduced relative to the socially optimum level.

Explanation:

Public goods have a marginal social benefit that is higher than the private demand curve. Absent intervention, the equilibrium will be at a lower price and quantity than the socially optimum level.

Example Question #3 : Effect On Socially Optimum Levels

Which of the following policies is most likely designed to address a positive externality?

Possible Answers:

The government increases the sales tax.

The government provides subsidies for preventative healthcare.

None of the answers are correct.

The government implements a tax on an industrial process that produces air pollution.

The government allocates the harvesting of fish through licenses.

Correct answer:

The government provides subsidies for preventative healthcare.

Explanation:

Preventative healthcare can have positive external benefits such as reduced expenses in the healthcare system and fewer days of missed work for employees.

The sales tax is not necessarily related to any externality, and the other answers address negative externalities.

Example Question #2 : Effect On Socially Optimum Levels

For years, producers in a perfectly competitive industry have been pumping waste into the air without penalty. If the government takes action to shift production to a more socially optimal level, what is the likely effect on equilibrium price and quantity in the market?

Possible Answers:

Price decreases, quantity decreases

Price increases, quantity increases

Cannot be determined

Price increases, quantity decreases

Price indeterminate, quantity decreases

Correct answer:

Price increases, quantity decreases

Explanation:

The pollution is a negative externality, or a cost of production that the supplier does not fully bear. Therefore, society's marginal cost, or supply, curve is shifted inward relative to the private marginal cost curve.

A policy that moves production toward this level would therefore result in a higher market price and lower market quantity.

Example Question #3 : Government Policies

Which of the following policies is most likely designed to correct for a negative externality?

Possible Answers:

The government imposes a tax on each pack of cigarettes sold.

None of the other answers are correct.

The government guarantees a minimum price to corn farmers.

The government offers subsidized loans to college students.

The government offers a tax credit for getting children vaccinated against a contagious disease.

Correct answer:

The government imposes a tax on each pack of cigarettes sold.

Explanation:

Smoking is associated with negative externalities such as second-hand smoke and costs to the healthcare system that are not fully borne by the smoker.

Higher education and vaccinations generally offer positive external benefits to society. Price minimums may be put in place for many reasons, but negative externalities are not likely one of them.

Example Question #3 : Effect On Socially Optimum Levels

For years a factory has been producing waste that it dumps into a nearby river. This waste negatively affects fishermen nearby. What government policy is most likely to get the factory to produce at the socially optimum level?

Possible Answers:

A tax on production equal to the difference between the private marginal cost and the social marginal cost

None of the other answers are correct.

Closing down the factory

Setting a maximum quota that the factory is allowed to produce each year

Requiring the factory to install a less-polluting technology

Correct answer:

A tax on production equal to the difference between the private marginal cost and the social marginal cost

Explanation:

A tax is the most efficient way to shift supply to the socially optimum level in a market with a negative externality such as this one. Regulations MAY have the desired effect, but they are likely to be inefficient.

Example Question #5 : Government Policies

To establish a socially optimal price for a natural monopoly, the government should select the price level at which ________________.

Possible Answers:

average total cost equals average revenue

average total cost equals average total revenue

marginal cost equals marginal revenue

marginal cost equals demand

marginal cost equals average revenue

Correct answer:

average total cost equals average revenue

Explanation:

In an unregulated market, a monopolistic firm makes economic profits by producing goods only until the marginal cost of production equals marginal revenue. This allows the firm to absorb the difference between average revenue and average cost for each product. To correct this, the government should select the price at which average revenue equals average total cost. This is the point at which the firm makes zero economic profit, produces the socially optimal quantity of goods, and sells at the socially optimal price. 

Example Question #4 : Effect On Socially Optimum Levels

Which of the following is true of public goods?

Possible Answers:

Public goods are rival and non-excludable.

Public goods are rival and excludable.

Public goods are non-rival and non-excludable.

Public goods are non-rival and excludable.

The price of public goods is determined by market factors.

Correct answer:

Public goods are non-rival and non-excludable.

Explanation:

The two main characteristics of public goods are that they are non-rival and non-excludable. Non-rival means that its use by one person does not prevent its use by another person. Non-excludable means that no one can be prevented from using the good.

Answer choice "The price of public goods is determined by market factors" is incorrect because public goods actually represent examples of market failures. Public goods are not subject to market factors the same way that other goods are.

All of the other answer choices are distortions of the characteristics of public goods and are therefore incorrect.

 

Example Question #9 : Effect On Socially Optimum Levels

The Gini coefficient is a measure of ________.

Possible Answers:

Gross National Product

income inequality

Gross Domestic Product

Net Exports

inflation

Correct answer:

income inequality

Explanation:

The Gini coefficient measures the income distribution among a particular population. A Gini coefficient of 0 represents total income equality and a Gini coefficient of 1 represents total income inequality.

The other answer choices refer to other economic indicators unrelated to the Gini coefficient.

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