10 - Externalities And Public Goods

Question 1

What is cost benefit analysis

Answer 1

If benefit is greater than cost then do it

• B (x activity) > C (x activity)

Question 2

What does efficiency require with people

Answer 2

Requires people to do activities where social benefit is greater than social cost

• SB (x activity) > SC (x activity)

Question 3

In the absence of externalities, private and social benefit and cost are what

Answer 3

They’re identical

Question 4

What are negative externalities and positive externalities

Answer 4

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

Question 5

It’s efficient to increase level of activity as long as….

Answer 5

Marginal social benefit (MSB) > Marginal social cost (MSC)

Question 6

What can externalities cause

Answer 6

Market inefficiency

Question 7

What’s private cost

Answer 7

The cost of production only, not including externalities

Question 8

What is social cost

Answer 8

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

Question 9

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

Answer 9

• 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

Question 10

What will a firm do in terms of quantity produced and price when externalities are taken into account as a monopoly

Answer 10

• 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

Question 11

If externalities are not checked what may it cause

Answer 11

Market failure, which is why governments intervene

Question 12

Where is the socially optimum output

Answer 12

The output where MSC = MSB

Question 13

Why does a deadweight loss occur in the competitive market in terms of externalities

Answer 13

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

Question 14

What’s The Coase Theorem

Answer 14

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

Question 15

What does the Coase theorem assume and what can you apply it too

Answer 15

• It assumes zero transaction costs
• It applies to positive and negative externalities

Question 16

Inefficiencies only occur according to Coase theorem if what

Answer 16

• If it’s costly or impractical to negotiate agreements

Question 17

Coase theorem shows market efficiency will result if there is….

Answer 17

• Clear property rights
• Costless negotiation

No free-market economy can function without laws that govern use of private property

Question 18

What is a pure public good

Answer 18

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)

Question 19

What’s a pure private good

Answer 19

A good that has a high degree of diminishability and excludability

Question 20

What is rivalry in consumption (diminishability)

Answer 20

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

Question 21

What is exclusion in consumption

Answer 21

Others can be prevented from consuming a good

• Non-excludability = If one cannot exclude others from enjoying its benefits

Question 22

What’s a collective good

Answer 22

A good that is excludable but has a high degree only of non-diminishability

Question 23

What’s an In pure public good

Answer 23

A good that has some non-diminishability and non-excludability

Question 24

What does the graph look like for a aggregate willingness to pay curve for a public good

Answer 24

• 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

Question 25

Optimal provision of public good (private company owns the public good), what happens to graph

Answer 25

• 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

Question 26

How do government fund public goods

Answer 26

• To produce at Q* it must raise sufficient tax revenue to cover total production costs

Question 27

Who assign greater value to public goods

Answer 27

The rich, because they have more money therefore their willingness to pay will most likely be higher than the poor

Question 28

Private provision of public goods - How would the private market fund these goods

Answer 28

• 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