AEDECON 2001 Chapter 10

externality

a side effect on bystanders whose interests aren’t fully taken into account

negative externality

harms bystanders, overproduction

positive externality

benefits bystanders, underproduction

marginal private cost

refers to the extra cost that the seller incurs to produce one more unit

marginal external cost

the extra cost imposed on bystanders from producing one more unit

marginal social cost

marginal private cost (paid by the seller) + marginal external cost borne by bystanders)

marginal private benefit

extra benefit enjoyed by bystanders

marginal social benefit

marginal private benefit (accruing to the buyers) + marginal external benefit (accrues to bystanders)

socially optimal quantity

the quantity that’s most efficient for society as a whole, occurs where marginal social benefit=marginal social cost

rational rule for society

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

analyzing externalities

1. predict equlibrium quantity to forecast what you think will happen

2. assess what externalities are involved

3. find the socially optimal quantity that is society’s best interest

4. compare your forecast of the equilibrium quantity with the socially optimal quantity

coase theorem

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

corrective tax 

can induce people to take account the negative externalities they create

corrective subsidy

can lead people to consider the positive externality that their actions generate

cap and trade

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

nonexcludable

means that other people cannot be easily excluded from using a product

nonrival

one person’s enjoyment or use of it doesn’t subtract from another’s enjoyment or use

free-rider problem

occurs when someone can ejoy the benefits of something without bearing the costs

rival good

when your use of a good comes at someone else’s expense

public good

a nonrival good that is nonexcludable and hence subject to the free-rider problem

facts about public goods

1. just because the government provides it doesn’t mean it is a public good

2. just because something is a public good doesn’t mean that the gov should fund it

3. just because the gov should fund a public good doesn’t mean the gov should provide it

club goods

excludable, nonrival; keeping out nonpaying customers

common resources

rival but nonexcludable; private gains but shared costs

tragedy of the commons

tendency to overconsume a common resource, occurs when rival goods are nonexcludable, assign ownership rights to solve this to ensure its not overused

solutions to the externality problem

1. private bargaining

2. fix the price: corrective taxes and subsidies

3. fix the quantity: cap and trade

4. laws, rules, regulations

5. government provision of public goods

6. assign ownership rights to common resources