Government's Role: Public Goods, Externalities, Taxes — High School Economics practice questions

A Pigouvian tax is designed to:

1. Replace antitrust policy
2. Maximize government revenue regardless of welfare
3. Always create a deadweight loss
4. Internalize a negative externality by aligning the private cost of an activity with its social cost

Answer: D — Internalize a negative externality by aligning the private cost of an activity with its social cost

D) Named for Arthur Pigou — tax equals the marginal external cost so producers face the true social cost. B) Welfare-improving, not just revenue. C) Done right, it reduces deadweight loss from the externality. A) Different policy tool.

A per-unit excise tax on cigarettes (a good with inelastic demand) is most likely to:

1. Reduce quantity sold sharply with little revenue
2. Have no effect on prices or quantity
3. Be borne mostly by sellers rather than buyers
4. Pass most of the burden to consumers because buyers respond little to the higher price; raises substantial revenue

Answer: D — Pass most of the burden to consumers because buyers respond little to the higher price; raises substantial revenue

D) Tax incidence falls more on the inelastic side. With inelastic demand, consumers absorb most of the tax via higher prices, and revenue is sizable. A) Quantity falls only modestly. B) Taxes raise prices. C) Wrong direction for inelastic demand.

A public good is best described as:

1. A good that is non-rival in consumption and non-excludable — e.g., national defense, lighthouses
2. A rival and excludable good — e.g., a sandwich
3. Any good owned by a single firm
4. A good that is always free in dollar terms

Answer: A — A good that is non-rival in consumption and non-excludable — e.g., national defense, lighthouses

A) Two defining characteristics. B) Private good. C/D) Off topic.

A factory dumps pollution into a river, harming downstream fishermen. The unpaid cost the factory imposes on the fishermen is best called:

1. A negative externality — a third-party cost not reflected in the factory's private cost or the market price
2. A public good
3. A positive externality
4. A subsidy

Answer: A — A negative externality — a third-party cost not reflected in the factory's private cost or the market price

A) Textbook negative externality: private production imposes uncompensated costs on third parties. B) Public goods relate to non-excludable/non-rival goods. C) Reverses the sign — trap. D) A subsidy is a payment, not a cost.

Which of the following is a common source of MARKET FAILURE that may justify government intervention?

1. A wide variety of substitute goods
2. Rapid technological progress
3. Externalities, public goods, monopoly power, and asymmetric information
4. Consumers with many choices

Answer: C — Externalities, public goods, monopoly power, and asymmetric information

C) Standard list of market-failure categories. A/B/D) All describe well-functioning markets, not failures.

Law of supply:

1. Price up, supply up
2. Random
3. No relationship
4. Quantity fixed
5. Holding other factors constant, when price rises, quantity supplied rises (and vice versa) — direct/positive relationship

Answer: E — Holding other factors constant, when price rises, quantity supplied rises (and vice versa) — direct/positive relationship

Law of supply: upward-sloping curve. Higher prices → producers willing/able to supply more (cover costs, profit). Foundation of producer theory. Demand AND supply together determine equilibrium price.

A PIGOUVIAN tax is designed to:

1. Maximize revenue regardless of welfare
2. Punish businesses generally
3. Fund public goods only
4. Set the tax equal to the MARGINAL EXTERNAL COST — making producers face the full social cost, restoring the efficient quantity

Answer: D — Set the tax equal to the MARGINAL EXTERNAL COST — making producers face the full social cost, restoring the efficient quantity

D) Named for Arthur Pigou; internalizes an externality by aligning private and social costs. A) Revenue is a byproduct, not the goal. B) Not punitive by design. C) Overlaps but not the definition.

The GINI coefficient measures:

1. The unemployment rate
2. The rate of inflation
3. Real GDP growth
4. Income (or wealth) INEQUALITY — 0 = perfect equality, 1 = maximum inequality

Answer: D — Income (or wealth) INEQUALITY — 0 = perfect equality, 1 = maximum inequality

D) Standard measure of distributional inequality; used in cross-country comparisons. A/B/C) Each is a different macro concept.

Which is the best example of a PUBLIC GOOD?

1. A bag of groceries
2. A ticket to a concert
3. National defense — non-rival (my protection doesn't reduce yours) and non-excludable (can't easily protect only payers)
4. A private car

Answer: C — National defense — non-rival (my protection doesn't reduce yours) and non-excludable (can't easily protect only payers)

C) National defense meets both defining tests. A/B/D) All are excludable and/or rival — classic private goods.

Market equilibrium occurs:

1. When supply > demand
2. Random price
3. Where supply and demand curves intersect — quantity demanded equals quantity supplied at the market-clearing price
4. Government-set price
5. Always lowest price

Answer: C — Where supply and demand curves intersect — quantity demanded equals quantity supplied at the market-clearing price

Equilibrium: Qd = Qs. No tendency to change. Above equilibrium price: surplus (sellers cut prices). Below: shortage (buyers bid up). Market forces drive toward equilibrium. Basis of price-adjustment mechanism.

How can governments address negative externalities?

Taxes (Pigouvian), regulations, tradable permits, lawsuits/property rights (Coase theorem).

How do progressive, proportional, and regressive taxes differ?

Progressive: rate rises with income (e.g., U.S. federal income tax). Proportional (flat): same rate for all. Regressive: rate falls with income (e.g., sales tax burdens lower incomes more).

What is the tragedy of the commons?

Shared resources tend to be overused and depleted because each individual user gains the benefit but shares the cost (e.g., overfishing).

What is the role of property rights?

Clear, enforced ownership encourages investment and trade — central to a functioning market economy.