Chapter 10 – Externalities and Public Goods (Vocabulary Review)

This set of vocabulary flashcards covers the essential terms and concepts from Chapter 10 on externalities, market failures, and public goods, providing definitions to reinforce understanding for exam preparation.

Externality

A side effect of an activity that affects bystanders whose interests are not taken into account, causing market outcomes to diverge from society’s best interest.

Negative Externality

A side effect that imposes costs on bystanders, leading to overproduction of the related good or activity.

Positive Externality

A side effect that yields benefits to bystanders, leading to underproduction of the related good or activity.

Market Failure

An inefficient market outcome—too much or too little of an activity—caused by externalities or other distortions.

Marginal Private Cost (MPC)

The extra cost paid by the producer from making one additional unit; represented by the supply curve.

Marginal External Cost (MEC)

The additional cost imposed on bystanders from producing one more unit.

Marginal Social Cost (MSC)

All marginal costs from producing one extra unit, equal to MPC plus MEC.

Marginal Private Benefit (MPB)

The extra enjoyment or value a buyer receives from purchasing one additional unit; represented by the demand curve.

Marginal External Benefit (MEB)

The additional benefit accruing to bystanders from one more unit consumed.

Marginal Social Benefit (MSB)

All marginal benefits from one extra unit, equal to MPB plus MEB.

Socially Optimal Quantity

The quantity where marginal social benefit equals marginal social cost, maximizing total welfare.

Internalizing the Externality

Altering incentives so that decision-makers take into account the external costs or benefits of their actions.

Coase Theorem

If bargaining is costless and property rights are clear, parties can privately negotiate to correct externalities and reach the socially optimal outcome.

Private Bargaining

A solution in which affected parties negotiate side payments to align individual incentives with social interests.

Side Payment

A transfer of money or value used in private bargaining to persuade someone to alter behavior that creates an externality.

Corrective Tax (Pigouvian Tax)

A tax set equal to the marginal external cost to reduce a negative externality and move output to the socially optimal level.

Corrective Subsidy

A payment equal to the marginal external benefit to encourage more of a positive-externality activity, reaching the socially optimal quantity.

Cap and Trade

A system that sets a quantity cap on total pollution and lets firms trade permits, concentrating production among the most efficient producers.

Quota

A regulation that sets a maximum quantity that can be produced or sold, used to limit negative-externality activities.

Laws, Rules, and Regulations

Command-and-control policies that restrict or mandate behaviors to curb negative externalities (e.g., noise ordinances, fuel-efficiency standards).

Excludable Good

A good for which non-payers can be easily prevented from using it.

Nonexcludable Good

A good for which it is difficult or impossible to prevent non-payers from using it.

Rival Good

A good where one person’s use diminishes the ability of others to use the same unit.

Nonrival Good

A good where one person’s use does not reduce availability to others.

Public Good

A good that is both nonexcludable and nonrival, often underprovided due to the free-rider problem.

Free-Rider Problem

When individuals enjoy benefits without paying, causing markets to underprovide nonexcludable goods.

Common Resource

A good that is rival but nonexcludable, prone to overuse and depletion.

Tragedy of the Commons

The tendency for common resources to be overconsumed because individual users ignore the shared costs they impose.

Assigning Ownership Rights

Converting a common resource into private property so the owner has incentives to manage and conserve it efficiently.