The reason externalities distort the allocation of resources is that:
a. too few goods are usually produced.
b. firms often go out of business because of the externality.
c. a firm's private costs do not reflect the social cost of production.
d. regulating externalities uses scarce resources.
Question 2
The Coase Theorem works best in places that transaction costs for contracts among people is low. Often in the world of torts and externalities both parties can claim that they have rights to impose on others. One case is that of a railroad that is noisy and scares the cattle and the rancher whose cattle sometimes wander in front of moving trains causing damage to them and the train. What does the Coase say would happen?
a. The train should have property right to be safe from wandering cattle, and the rancher should be liable for train damage of rampaging cattle.
b. The rancher should have the property right to be safe from noisy trains, and the railroad should be liable for weight loss of cattle from train whistles and rumbling noise.
c. If transaction costs are low, the efficient activity will occur, either the rancher or railroad installing fences to protect from rampaging cattle and/or sound insulation with trees, or if it is cheaper, fewer train trips per day. The cheapest or most efficient solution will happen, regardless of who is assigned the original property right.
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