1.3.2 Externalities Flashcards
Externalities
economic “spill-over” effects which are not included in the price and impact those not related to the economic transaction (regarded as a market failure)
Market failure
a situation in which the free market fails to allocate resources efficiently
External costs (negative externalities)
occur when the social costs of an economic action are greater than the private cost (social cost= private cost + external cost) (e.g pollution from factory)
External benefits (positive externalities)
occur when the social benefits of an economic action are greater than the private benefits (social benefits = private benefits + external benefits) (education)
Explain how education might be an external benefit
- The education received by a child means they can get a job that have reasonable income (private)
- The child’s education may benefit wider society if she becomes a doctor and treat people so they can go to work (external benefit)
Private cost and benefit for gum on consumer
- Cost: the price of gum
- Benefits: Enjoyment from eating the gum
External cost and benefit for gum on consumer (society)
- Cost: The costs to councils of both scraping off spat-out gum from pavements and collecting discarded packets
- Benefits: oral hygiene
Private cost and benefit for gum on producer
- Cost: Manufacturing, marketing costs
- Benefits Sales revenue and profit
External cost and benefit for gum on producer
- Cost: Pollution from the factory, congestion from the lorries
- Benefits: None
Negative externality diagram
Positive externality diagram
Impact on economics agents of externalities and govt intervention examples
- gum neg externality: gum on the street which gets stuck on people’s shoes and the govt have to clean (gum have a higher social cost than private cost)
Policy options for negative externalities
- “Nudge”
- Prohibition
- Indirect/specific tax
- Quota system
- Regulation
- Information provision
- Subsidise more favourable substitutes
Nudge policy for negative externalities
change people’s behaviours e.g by providing easier alternate options (e.g bins for gum)
Prohibition for negative externalities
putting a ban on certain things (with penalties)
- gum ban in SIngapore or DDT pesticides being banned
Indirect/specific tax for negative externalities
- use tax to offset the externality
- to internalise the externality of the tax passed (so the social cost becomes a private cost (hypothecation)
Quota system for negative externalities
the negative externality is capped at a certain amount (e.g carbon trading units) e.g Kyoto Protocol
What is the carbon trading scheme?
- a body set a cap on carbon emissions by giving out a certain amount of carbon units
- If a company has more carbon units than needed, than can sell them to other countries/companies
- this makes polluters pay and rewards low carbon emissions
Regulation for negative externalities
allow occurrence at certain times
Information provision for negative externalities
the impacts of cigarettes on packs
Subsidies more favourable for negative externalities
e.g green energy paid for
Evaluation of policy for negative externalities
- quantification of the externality & knowing the point at which MSC=MSC is difficult
- putting a monetary value on the deadweight loss is difficult to achieve
Disadvantages of Prohibition for negative externalities
may create illegal markets e.g black markets
Disadvantages of Indirect/specific tax for negative externalities
the tax effects may be regressive and the impacts may fall more heavily for poorer people
DIsadvantages of regulation
- the costs of implementation
- monitoring & managing some of the options may be prohibitive
Disadvantages of Quota system for negative externalities
global agreements are very difficult to achieve
Disadvantages of Subsidies more favourable for negative externalities
subsidies have financial & opportunity costs which may create a dependency on the subsidy
Positive externalities in consumption definition
a situation in which the free market leads to an under-consumption of a g/s relative to the social optimal (e.g education and vaccines)
Diagram to show a positive consumption externality:
Diagram to show a positive consumption externality with subsidy:
How to achieve the social optimal/ social efficiency/welfare maximising (increase consumption of positive externalities)?
- Subsidise to push the price down to achieve the socially optimal quantity
- Compulsion / mandatory (eg education / Tetanus MMR vaccines)
- State provision free of charge
Positive consumption externality diagram explanation
- where MPC (s) = MPB (d)
- the social efficient equilibrium is higher the market equilibrium since the MSB (social benefit) is greater than the MPB (private benefit)
- the welfare gain is the external benefit that the market has used due to underconsumption
Result of positive externalities
- creates a 3rd party spillover benefit
- the social benefit of production/consumption is greater than the private benefit
- external benefit might be in the form of lower cost for other parties or increased revenue/profits for other parties
Why is education a merit good?
- Private benefit: job and income
- Social benefit: better skills= increased productivity, more social opportunities, increased living standards, higher income= more consumption and money spent on economy/expenditure, increase in tax revenue to govt = government expenditure
Advantages of imposing an extra charge for vehicles
- allows polluters to pay for negative externalities
- taxes as a hard nudge to drive investment )buy less polluting cars)
Disadvantages of imposing an extra charge for vehicles
- regressive effect on poorer households (= increase demand of public transport)
- small businesses face extra costs = reduce profits = contraction in employment
- other alternatives = have car free days
