ECON Ch10: Externalities

externality

a side effect of an activity that affects bystanders whose interests are not taken into account

negative externality

a side effect that harms bystanders

positive externality

a side effect that benefits bystanders

harm bystanders

Negative externalities are side effects that ____ _____.

benefit bystanders

Positive externalities are side effects that ____ ___

overproduction

Negative externality activities cause _______.

underproduction

Positive externality activities cause _______.

not an externality

A price change is ______.

private interest

costs and benefits that you personally incur

society’s interest

includes all costs and benefits

marginal private cost

the extra costs paid by the seller from producing one extra unit

marginal external cost

the extra cost imposed on bystanders from producing one extra unit

marginal social cost

all marginal costs, no matter who pays them

marginal private costs + marginal external costs

marginal social costs =

marginal private benefit

the extra enjoyment by the buyer from purchasing one extra unit

marginal external benefit

the extra benefit accruing to bystanders from one extra unit

marginal social benefit

all marginal benefits, no matter who gets them

marginal private benefit + marginal external benefit

marginal social benefit =

socially optimal quantity

the quantity that is most efficient for society as a whole, including the interests of buyers, sellers and bystanders

rational rule for society

produce more of an item as long as its marginal social benefit is at least as large as the marginal social cost

marginal social benefit = marginal social cost

Socially optimal quantity is located where ____________.

equilibrium quantity

Predict the ______ ____ to forecast what you think will happen.

externalities

Assess what _____ are involved.

socially optimal quantity

Find the _____ ____ _____ that is in society’s best interest.

compare

_____ your forecast of the equilibrium quantity with the socially optimal quantity.

too much

When businesses do not account for the full costs of the pollution they emit, they do ___ ____ relative to what’s in society’s interest.

right balance

Socially optimal quantity seeks to find the ____ ______ upon consideration of all the costs and benefits.

marginal social cost

The supply curve is also the ___ ___ ___ curve.

too little

When people do not account for the full benefits of the activity they do, they do ___ ____ relative to what is in society’s interest.

marginal social costs

Marginal private costs underestimate _______.

marginal social benefit

Marginal private benefits underestimate _________.

internalize the externality

To solve externality problems, find a way to ______ __ _____.

Coase Theorem

if bargaining is costless and property rights are clearly established and enforced, then externality problems can be solved by private bargains

neighbor’s loud music and humana health insurance

examples of private bargaining

side payments for negative externalities

if someone else’s actions harm you, you can pay them to do something else instead

side payments for positive externalities

if someone else’s actions help you, you can pay them to do more of that activity

negative externality solution

set the corrective tax equal to the external cost

corrective tax

a tax designed to induce people to take account of the negative externality they cause → incentivizes people to do less of the activity

positive externality solution

set the corrective subsidy equal to the external benefit

corrective subsidy

a subsidy designed to induce people to take account of the positive externalities they cause → incentivizes people to do more of the activity

corrective subsidy

lead people to consider the positive externalities that their actions generate

equal to

For a negative externality solution, set the quantity cap ____ __ the socially optimal quantity.

the quota corrects the overproduction issue

What does the quota on a negative externality solution do?

cap and trade

a quantity regulation implemented by allocating a fixed number of permits, which can then be traded

cap

reduces pollution by setting a maximum cap on the total amount of pollution that can be emitted

trade

efficient firms buy permits from inefficient firms → concentrates production among businesses that use more efficient, cleaner technology

noise restrictions, speeding and safety laws

examples of laws, rules and regulations that can help solve problems caused by negative externalities

nonexcludable

Externality problems are linked to _______ products.

excludable

when someone can be easily excluded from using something

nonexcludable

when someone cannot be easily excluded from using something

rival

when your use of something comes at someone else’s expense

nonrival

when one person’s use does not subtract from another’s

rival and excludable

private goods

nonrival and excludable

club goods

rival and nonexcludable

common resources

nonrival and nonexcludable

public goods

free-rider problem

when someone can enjoy the benefits of a good without bearing the costs → issue with nonexcludable goods

use tax money, purchase public goods from businesses

How can the government help provide public goods?

common resource

a good that is rival and also nonexcludable → private gains but shared costs

tragedy of the commons

the tendency to overconsume a common resource

ownership rights

Assign ______ ___ so that now someone owns the common resource.