Chapter 7: Externalities and Public Goods

Vocabulary flashcards defining core concepts, formulas, and classifications from Chapter 7 on Externalities and Public Goods.

Externality

A cost or benefit affecting someone outside the transaction.

Negative externality

An externality in which outsiders bear a cost, causing the market to produce too much compared with the socially optimal quantity ($Q\text{-market} > Q\text{-social}$).

Positive externality

An externality in which outsiders receive a benefit, causing the market to provide too little compared with the socially optimal quantity ($Q\text{-market} < Q\text{-social}$).

Social (in social cost or benefit)

Refers to everyone affected, not just the buyer, seller, or government.

Social cost

The sum of private cost and external cost ($\text{Social cost} = \text{Private cost} + \text{External cost}$), representing the business's bill plus the neighbors' bill.

Social benefit

The sum of private benefit and external benefit ($\text{Social benefit} = \text{Private benefit} + \text{External benefit}$), representing your benefit plus everyone else's bonus.

Internalizing an externality

Bringing the outside cost or benefit into the decision-maker's incentives, putting the hidden bill on the receipt.

Corrective tax

A policy designed to help correct a negative externality by making decision-makers account for external costs.

Subsidy

A policy designed to help correct a positive externality by encouraging an activity with benefits for others.

Marginal social cost (MSC)

The marginal cost that includes external damage; it is higher than marginal private cost ($MPC$) on a standard pollution graph.

Marginal social benefit (MSB)

The marginal benefit that includes benefits to outsiders; it is higher than marginal private benefit ($MPB$) in a positive consumption externality.

Socially optimal quantity

The quantity where marginal social benefit equals marginal social cost ($MSB = MSC$).

Deadweight loss

Lost total surplus that can arise from harmful extra units or beneficial missing units.

Excludable

A characteristic of a good indicating that people can reasonably be prevented from using it if they do not pay.

Rival

A characteristic of a good indicating that one person's use reduces what is available for others.

Private good

A good that is both excludable and rival, such as a sandwich.

Club good

A good that is excludable and nonrival, such as subscription streaming before congestion occurs.

Common resource

A good that is nonexcludable and rival, such as fish in an open-access fishing area.

Public good

A good that is nonexcludable and nonrival, such as a fireworks display visible throughout a neighborhood.

Free rider

Someone who benefits from a good without contributing or paying for it.

Free-rider problem

The challenge that public goods can be underprovided because collecting payment from users is difficult.

Tragedy of the commons

The problem where a shared, rival resource gets overused because individuals race to use it before others do.

Cost-benefit analysis

Comparing the benefits and costs of providing a good or undertaking a project.

Coase theorem

The idea that with clearly defined property rights and no barriers to bargaining, parties can negotiate an efficient outcome.