Econ Test #3 (Environmental Protection and Negative Externalities)

What are the main functions of government in economics?

Provide law and order and protect property rights.

What are property rights?

Legal ownership that gives people incentives to take care of their property.

What is the “invisible hand”?

Adam Smith’s idea that self-interest can lead to the best outcome for society.

What is a market failure?

When the market does not produce the most efficient outcome.

What are two main causes of market failure?

Externalities and public goods.

What is an externality?

A cost or benefit that affects someone not directly involved.

Why do externalities cause inefficiency?

They prevent maximizing total social surplus.

What causes externalities?

Missing or weak property rights and no price on something valuable.

What is a negative externality?

A harmful side effect affecting others.

What happens when a negative externality exists?

Too much of the good is produced.

Give examples of negative externalities.

Pollution, loud noise, second-hand smoke.

What is private cost?

The cost paid by the producer.

What is social cost?

Private cost plus external cost.

How do social costs compare to private costs with negative externalities?

Social costs are higher.

What is the socially optimal level of output?

Where marginal benefit equals marginal social cost.

How does optimal output compare to market output with negative externalities?

Optimal output is lower.

What does it mean to internalize an externality?

Make people consider the external costs/benefits.

What are command-and-control regulations?

Laws that limit pollution or require specific technology.

What are problems with command-and-control?

Inflexible, no incentive to improve, and political compromises.

What is a Pigovian tax?

A tax equal to the external cost of pollution.

What is the goal of corrective taxes?

Reduce production to the optimal level.

What are problems with Pigovian taxes?

Hard to calculate and may cause inefficiencies.

What are tradable pollution permits?

Permits that allow firms to buy/sell the right to pollute.

How do tradable permits reduce pollution?

Firms that can reduce cheaply will do so and sell permits.

Why is it hard to measure environmental benefits?

Future impacts and values are uncertain and subjective.

What is the optimal level of pollution reduction?

Where marginal benefit equals marginal cost.

Should pollution be reduced to zero?

No, because costs would be too high.

What tradeoff do societies face?

Economic output vs environmental protection.

How do low-income vs high-income countries differ?

Low-income prioritize output; high-income prioritize environment.

What are examples of private solutions?

Moral rules, charities, contracts, and business agreements.

What is the Coase Theorem?

If property rights are clear and costs are low, people will reach efficient outcomes on their own.

What are transaction costs?

Costs of making and enforcing agreements.

Why might private solutions fail?

High transaction costs, stubbornness, or coordination problems.