10 - Externalities And Public Goods Flashcards
What is cost benefit analysis
If benefit is greater than cost then do it
- B (x activity) > C (x activity)
What does efficiency require with people
Requires people to do activities where social benefit is greater than social cost
- SB (x activity) > SC (x activity)
In the absence of externalities, private and social benefit and cost are what
They’re identical
What are negative externalities and positive externalities
Negative externalities = An activity that imposes external costs on others
- E.g. mining firm pollutes a lake people use for recreation (between firms and people)
Positive externalities = An activity that creates external benefits for others
It’s efficient to increase level of activity as long as….
Marginal social benefit (MSB) > Marginal social cost (MSC)
What can externalities cause
Market inefficiency
What’s private cost
The cost of production only, not including externalities
What is social cost
The private cost (cost of production) + the cost from externalities (I.e. pollution)
- So, the presence of externalities may cause a market to operate inefficiently
What will a firm do in terms of quantity produced and price when externalities are and are not taken into account in a perfectly competitive market
- When externalities are NOT taken into account, the firm will over produce and charge lower prices (this is efficient)
- When externalities ARE taken into account, the firm will produce less and charge more as this is the marginal social cost (less efficient)
The graph is a normal supply and demand graph, with marginal social cost line going up just above supply curve from the origin creating a new equilibrium
What will a firm do in terms of quantity produced and price when externalities are taken into account as a monopoly
- They have market power, therefore set price above marginal cost (MC), causing inefficiency
- Monopolies produce too little and charge high
Marginal cost line is horizontal, with marginal social cost going up from the beginning of marginal cost line
If externalities are not checked what may it cause
Market failure, which is why governments intervene
Where is the socially optimum output
The output where MSC = MSB
Why does a deadweight loss occur in the competitive market in terms of externalities
Competitive market equates price with private marginal cost instead of social marginal cost, therefore doesn’t take into account externalities
- competitive market produces excessive negative externalities
What’s The Coase Theorem
When the parties affected by externalities can negotiate costlessly with one another, an efficient outcome results no matter how the law assigns responsibility for damages
What does the Coase theorem assume and what can you apply it too
- It assumes zero transaction costs
- It applies to positive and negative externalities
Inefficiencies only occur according to Coase theorem if what
- If it’s costly or impractical to negotiate agreements
Coase theorem shows market efficiency will result if there is….
- Clear property rights
- Costless negotiation
No free-market economy can function without laws that govern use of private property
What is a pure public good
A good that has a high degree of non-diminishability (non-rivalry, more than one person can consume the good) and non-excludability (no one can be prevented from using the good)
What’s a pure private good
A good that has a high degree of diminishability and excludability
What is rivalry in consumption (diminishability)
Only one person can consume a good
- Example, a sandwich at Tesco, once you get it no one else can get that specific sandwich; therefore is diminishable
What is exclusion in consumption
Others can be prevented from consuming a good
- Non-excludability = If one cannot exclude others from enjoying its benefits
What’s a collective good
A good that is excludable but has a high degree only of non-diminishability
What’s an In pure public good
A good that has some non-diminishability and non-excludability
What does the graph look like for a aggregate willingness to pay curve for a public good
- The curves are vertical as it’s public goods; private goods are horizontal
- At the beginning of the curve downwards, it is steeper both people are consuming it as it’s a public good
- At the end, there’s a kink and it becomes flatter, as the person who’s willing to pay higher consumes it only
Optimal provision of public good (private company owns the public good), what happens to graph
- If you let private market supply the public good, they’ll want to profit maximise
- That’s why there’s an MC curve that crosses at the maximum willingness to pay
- This provision leads to market failure
- Private market cannot change the public good
- Private market under-provide these public goods, why government steps in
How do government fund public goods
- To produce at Q* it must raise sufficient tax revenue to cover total production costs
Who assign greater value to public goods
The rich, because they have more money therefore their willingness to pay will most likely be higher than the poor
Private provision of public goods - How would the private market fund these goods
- Donation - everyone who benefits chips in
- Free riding = Choosing not to donate to a cause, but benefiting from the donation
- Sale of by-products
- Private contracts
