2.2 Externalities Flashcards
positive consumption externality
MSB = MPB + MEB
=> MSB > MPB
negative consumption externality
MSB = MPB + MEC
=> MSB < MPB
positive production externality
MSC = MPC + MEB
=> MSC < MPC
negative production externality
MSC = MPC + MEC
=> MSC > MPC
what is a negative production externality
when the production of a good/service has a negative impact on a third party not involved in producing or consuming the good
is externality market failure?
an externality is not market failure in itself; but it can cause market failure when ignored by market decision makers
examples of negative production externalities
- pollution from factory causing health problems for local residents
- traffic congestion caused by the rebuilding of a road
- resource depletion/ degradation
- deforestation
what is a positive production externality
when the production of a good/service has a positive impact on a third party not involved in the producing or consuming of the good
examples of positive production externalities
- increase employment and economic growth
- biodynamic farming promotes biodiversity and a habitat for pollinators
- the production of manneure from livestock fertilizes soil
what is a negative consumption externality
when the consumption of a good/service has a negative impact on a third party not involved the producing or consuming of the good
examples of negative consumption externalities
- smokers
- fireworks
- alcohol
- fossil fuel-consuming vehicles
what is a positive consumption externality
when the consumption of a good/service has a positive impact on a third party not involved in the production or consumption of the good
examples of positive consumption externalities
- vaccines (preventative healthcare)
- sustainable forms of transport
- deodorant
- renewable energy
- education
source of market failure
decisions are based on private costs/benefits but welafre is maxmised when the full social costs/benefits are considered
Explaining externalities with a diagram
(1) say whether social cost/benefit is greater than private
(2) explain the private side
(3) explain the social side
(4) say why its the socially ptimum point (MSB = MSC)
(5) say what form of market failure is happenign
policies to correct market failure caused by negative externalities
- indirect taxes
- carbon taxes
- tradeable pollution permits/caps
- government regulations
- information campaigns
indirect taxes to correct negative production externalities
1) gov’t sets tax = per unit externality, S curve shifts inwards to S(MPC+tax) creating a new equilibrium at q.so. (qtax)
2) the market operates @ the s.o. level of output => welfare loss is eliminated
3) price increases from Pm to Ptax - higher price now refelect the full cost of the good
4) gov’t gains tax revenue
indirect taxes to correct negative consumption externalities
1) tax is used to shift the supply curve inwards so that it intersect with D(MPB) at Qs.o.
2) the market operates at the s.o. levle of output => welfare loss is eliminated
3) price increases so that the higher price now reflects the full cost of the good
4) gov’t gains tax revenue
evaluation of using indirect taxes to correct negative externalities
- the effectiveness depends on how easily measureable the externality is
- the effectiveness of the tax depends on the magnitude of the tax in relation to the externality
- the incidence of the tax depends on elasticity
- they are regrefessive
- poorly targeted
why are indirect taxes poorly targeted
because the taxes are not focused on the consumers or producers that are engaged in the harmful behaviour, so they don’t offer an incentive to change the behaviour
incidence of the tax
PED elastic => firms pay
PED inelastic => consumers pay
negative externality that carbon taxes aim to correct
global warming:
- increased risk of natural disaster
- risks to good security/famine
- costs of mirgation as people escape inhospitable environments
how do carbon taxes work
(1) they raise business costs for firms, causing them to internalize the externality and shift supply to the left
(2) they create an incentive for firms to swtich to green energy
pros of carbon taxes
- enoucrage firms to switch to green energy
- increases the s.o. optimum quantity of output
- easier to implement/design
- can be applied to all fossil fuel using industries
- does not require as much monitoring or enforcement
- makes energy prices more predictable
cons of carbon taxes
- taxes face political pressures t be set too low
- cannot target a particular level of carbon reducation
- are regressive
market for permits
- the supply of permits is perfectly inelastic because there is a fixed supply of permits
- the price of the permits is determined by demand
how do tradeable permits address the externality problem?
(1) immediately reduces the amount of carbon (externality) produced and raises costs for firms
(2) incentive impact
types of gov’t regulations to prevent negative externalities
- ban on gum chewing in singapore
- bans on smoking in public places
- policies requiring consumers to pay for waste dispsoable bags
- regulations on chemical affluents
- regulations on diesel cars
- quantity restrictions on certain purchases
- age restrictions
- gun laws
evaluation of regulation
- fixing the appropriate level of regulation
- the costs to firms of emeting the regulations
- impact on international competitiveness
examples of tradeable permit schemes
european union emissions trading sysetms (2005)
- never been high enough to be effective
another word for trabale permits
emissions trading system (ETS)
limitations of tradable permits
- political favorutism
- research and technical info required to set up
- if cap set too low, firms struggle to produce
- makes prices unpredictable
- often only targets on industry/small group
policies to correct market failure due to positive externalities or merit goods
- subsidies
- direct provision
- legislation/regualtion
- information campaigns
-nudges
limitations of subsidies
- effect depends on PED
- difficult to estimate externality
- danger firms may become to reliant on subsidies
- opportunity cost to gov’t budget
limitations of government regulation
- can often over-correct (e.g. bans)
- don’t tackle the root problem
pros of gov’t regulation
- can target certain areas
- do not rely on changes in consumer behaviour
subsidies to correct market failure due to positive consumption externalities
- aim to set the per unit subsidy equal to the per unit externality so that supply shifts out and intersects demand at qso.o
- subsidy lowers price from Pm to psubs and increases quantity sold (correcting the welfare loss)
- both producer and consuer surplus increases
- cost to the gov’t of per unti subsidy x quantity sold
direct provision to correct amrket faillure due to positive consumption externalities
- gov’t supplements market supply with its own provision
- price down and quantity sold increases
examples of direct provision to correct market failure due to positive consumption externalities
- public education
- contraception
- vaccinations
example of government regulation to correct market failure due to cosumption externalities
- schools require SexEd for students
- education currciulums
- masks compulsory
- eduation laws
- car insurance required
- vaccine passports in korean
-washing your hands campaigns
