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Question from Past Microeconomics Qualifying ExamEdit

Fall 2004 - Section I, Question two, George Mason University

T, F, U. State first whether the following statements are true, false or uncertain. Then briefly explain your reasoning in four or five sentences. You may use a graph if it helps clarify your answer.

If a government-created monopoly is creating negative externalities, making the market contestable will definitely lead to a more efficient outcome.

AnswerEdit

Uncertain. A monopoly situation is usually characterized by lower than competitive output. If that itself is regarded as a negative externality than, yes making the market contestable will definitely lead to a more efficient outcome.

However, if the negative externality and inefficient outcome are due to some technological inability to assign property rights, then even a contestable market might not remove the negative externality.

In the standard example of a factory polluting the air/water the inability to fully assign property rights to clean air/water would keep even a competitive market from achieving an efficient outcome and remove the externality.

In fact a contestable market situation might even lead to an increase in the total negative externality, because output is likely to increase in a competitive situation.

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