10a. Externalities and Public Goods Flashcards
What is an “externality”?
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.
What is a “negative externality”?
An economic activity that has a direct negative spillover effect,
i.e. that reduces the welfare of someone else without compensating for the loss.
What’s an example of a “negative externality”?
Pollution
Does a market produce too much or too little of a good with negative externalities?
A competitive market produces TOO MUCH of the good with negative externalities.
What is a “positive externality”?
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.
What’s an example of a “positive externality”?
eg. Education, Vaccinations
Does a market produce too much or too little of a good with positive externalities?
A competitive market produces TOO LITTLE of the good with positive externalities.
How is “education” a positive externality?
- Higher individual wages = more tax revenues
- Less reliance on social programs
- Decreased crime
- More innovation
- Better functioning society
- Better health
What is MCp?
Marginal PRIVATE cost
-> The cost of production only, not including externalities
What is MCg?
Marginal cost of EXTERNAL damage to the community
What is MCs?
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
What area is the DWL?
E
What externality does this DIG show?
POSITIVE EXTERNALITY
(in a competitive market)
What is the social optimum of consumer surplus?
A
What is the real consumer surplus?
A + B + C + D
What is the real Private Producer surplus?
F + G + H
What is the real externality cost?
C + D + G + H + E
What is the real welfare?
A + B + F - E
What is “private cost”?
The cost of production only, not including externalities.
What is “social cost”?
The private cost plus the cost of the harms from externalities.
What could a government do to regulate externalities?
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
What are “market-based policies”?
- 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
What is happening in this DIG?
Applying a specific tax of $84 per ton of paper results in the social optimum level!
As this pushes MCp onto the MCs quantity!
What is a “pigouvian tax”?
The tax necessary to incentivize a firm to produce the socially optimal level of output
