Externalities in Microeconomics

A collection of vocabulary flashcards based on key concepts related to externalities in microeconomics.

Externality

The uncompensated impact of one person’s actions on the well-being of a bystander.

Negative externality

An adverse impact on bystanders arising from an individual’s actions.

Positive externality

A beneficial impact on bystanders arising from an individual’s actions.

Internalizing the externality

Altering incentives so that individuals take into account the external effects of their actions.

Command-and-control policies

Regulations that directly limit the behavior of firms or individuals.

Market-based policies

Incentives that encourage private decision-makers to solve externality problems on their own.

Corrective taxes (Pigovian taxes)

Taxes designed to induce private decision makers to take into account the social costs of negative externalities.

Tradable pollution permits

Permits that allow firms to emit a certain amount of pollution, which can be bought and sold.

Coase theorem

The theory that if private parties can bargain without cost, they can solve the problem of externalities on their own.

Transaction costs

Costs that parties incur in the process of agreeing to and following through on a bargain.

Social cost

The total cost to society, including both private and external costs.

Social value

The total value to society, including both private value and external benefits.

Efficient outcome

An outcome where resources are allocated in a way that maximizes total welfare.

Consumer surplus

The difference between what consumers are willing to pay for a good and what they actually pay.

Producer surplus

The difference between what producers are willing to accept for a good and what they actually receive.

Private solution

A resolution to an externality problem that does not involve government intervention.

Public policies towards externalities

Government strategies undertaken to mitigate the impacts of externalities.

Welfare economics

The study of how the allocation of resources affects economic well-being.

Externality

one type of market failure

private value

the value to buyers (the prices they are willing to pay).

private cost

 the costs directly incurred by sellers.

External cost 

value of the negative impact
on bystanders

If market participants pay social costs

Market equilibrium = social optimum

If negative externality

Market quantity larger than socially desirable

If positive externality

Market quantity smaller than socially desirable