Externalities, the Coase Theorem, and Corrective Policies

Vocabulary flashcards covering positive and negative externalities, market failure, deadweight loss, Ronald Coase's theorem, Pigouvian corrective taxes, and subsidies based on the economics lecture.

External Cost

A real cost imposed on society as a whole that exists outside of the market transaction and is not accounted for by producers or consumers when making economic decisions.

Social Cost

The total cost of production to society as a whole, calculated by adding the external cost to the marginal private cost.

Negative Externality

A harmful side effect or external cost imposed on third parties when a good or service is bought and sold, leading the free market to overproduce relative to the socially efficient outcome.

Positive Externality

A beneficial side effect or external benefit experienced by third parties or society at large from a market transaction, causing an unregulated market to underproduce relative to the socially efficient quantity.

Marginal Social Cost Curve ($S_2$)

A supply curve located above the marginal private cost curve ($S_1$) that accounts for both the private production costs and the external cost of pollution.

Market Failure

A situation in which an unfettered market fails to allocate resources efficiently, resulting in deadweight loss through overproduction or underproduction.

Coase Theorem

A concept formulated by economist Ronald Coase stating that private parties can bargain without government intervention to reach an efficient outcome that eliminates deadweight loss, regardless of how property rights are initially assigned, provided specific market conditions are met.

Conditions of the Coase Theorem

The three requirements necessary for private bargaining to solve externalities: clearly assigned and enforceable property rights, low transaction costs, and full information about costs and benefits.

Pigouvian Tax (Corrective Tax)

A per-unit tax set equal to the size of a negative externality, introduced to shift the private supply curve up to the marginal social cost curve, reducing output to the socially optimal level.

Double Dividend of Taxation

The dual benefit of a Pigouvian tax, which both increases market efficiency by reducing deadweight loss from an externality and raises government revenue that can replace other inefficient, distortionary taxes.

Subsidy

A financial payment or incentive provided by the government to lower private costs or increase private benefits, used to raise consumption and production of goods with positive externalities to the efficient quantity.

Herd Immunity

A positive externality resulting from vaccination where widespread individual immunization prevents pathogens from circulating, thereby protecting unvaccinated or immunocompromised members of the population.