10a. Externalities and Public Goods

Question 1

What is an “externality”?

Answer 1

the direct effect of the actions of a person or firm on another person’s wellbeing or a firm’s production capability rather than an indirect effect through changes in prices.

Question 2

What is a “negative externality”?

Answer 2

An economic activity that has a direct negative spillover effect,

i.e. that reduces the welfare of someone else without compensating for the loss.

Question 3

What’s an example of a “negative externality”?

Answer 3

Pollution

Question 4

Does a market produce too much or too little of a good with negative externalities?

Answer 4

A competitive market produces TOO MUCH of the good with negative externalities.

Question 5

What is a “positive externality”?

Answer 5

An economic activity that has a direct positive spillover effect,

i.e. that increases the welfare of someone else without being compensated for the benefit generated.

Question 6

What’s an example of a “positive externality”?

Answer 6

eg. Education, Vaccinations

Question 7

Does a market produce too much or too little of a good with positive externalities?

Answer 7

A competitive market produces TOO LITTLE of the good with positive externalities.

Question 8

How is “education” a positive externality?

Answer 8

• Higher individual wages = more tax revenues
• Less reliance on social programs
• Decreased crime
• More innovation
• Better functioning society
• Better health

Question 9

What is MCp?

Answer 9

Marginal PRIVATE cost
-> The cost of production only, not including externalities

Question 10

What is MCg?

Answer 10

Marginal cost of EXTERNAL damage to the community

Question 11

What is MCs?

Answer 11

Social marginal cost (MCs):

The cost of manufacturing one more ton of paper to the paper firms plus the additional externality damage to people in the community from producing this last ton of paper

Question 12

What area is the DWL?

Answer 12

E

Question 13

What externality does this DIG show?

Answer 13

POSITIVE EXTERNALITY
(in a competitive market)

Question 14

What is the social optimum of consumer surplus?

Answer 14

A

Question 15

What is the real consumer surplus?

Answer 15

A + B + C + D

Question 16

What is the real Private Producer surplus?

Answer 16

F + G + H

Question 17

What is the real externality cost?

Answer 17

C + D + G + H + E

Question 18

What is the real welfare?

Answer 18

A + B + F - E

Question 19

What is “private cost”?

Answer 19

The cost of production only, not including externalities.

Question 20

What is “social cost”?

Answer 20

The private cost plus the cost of the harms from externalities.

Question 21

What could a government do to regulate externalities?

Answer 21

Might control pollution directly by restricting the amount of pollution that firms may produce
-> emissions standard

OR

By taxing them for pollution they create.
eg. Effluent charge—tax on discharges into the air or waterways

Question 22

What are “market-based policies”?

Answer 22

• Taxes and Subsidies.
• Change incentives, align incentives to pursue social optimum. Make firm internalizes the externality.

Example with pollution:
-> emissions fee – tax on air pollution
-> effluent charge - tax on discharges into the air or waterways

Question 23

What is happening in this DIG?

Answer 23

Applying a specific tax of $84 per ton of paper results in the social optimum level!

As this pushes MCp onto the MCs quantity!

Question 24

What is a “pigouvian tax”?

Answer 24

The tax necessary to incentivize a firm to produce the socially optimal level of output

Question 25

What is a “pigouvian subsidy”?

Answer 25

The subsidy necessary to make an economic agent increase consumption to the socially optimal level