3.8.4 - Positive and Negative Externalities in Production and Consumption Flashcards

1
Q

What are externalities?

A

A public good or a public bad that is ‘dumped’ on third parties outside the market.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

When do externalities exist?

A

When there is a divergence between private and social costs / benefits.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What type of good is an externality?

A

A public good.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What type of good is an externality?

A

A public good.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Why is an externality a special type of good?

A

It is ‘dumped’ on third parties who are forced to consume it, whether or not they want to.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is a postitive externality?

A

An external benefit that occurs when the consumption of a good causes costs to a third party, where social cost is greater than the private cost.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is a negative externality?

A

When the consumption or production of a good causes costs to a third party, where social cost is greater than the private cost.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

How can negative externalities be corrected?

A

By ‘internalising’ the externality.

i.e. if a producer has a production externality of high pollution causing people nearby to develop cancer, the people can sue the producer to create a market where there was not one originally.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a property right?

A

The exclusive authority to determine how a resource is used.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

How are property rights defended in modern capitalist societies?

A

The legal system.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

How do externalities affect private property rights?

A

The owner of the private property cannot prevent passers-by from enjoying the view of the house.

Passers-by can free-ride despite not paying for the good.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

How do externalities affect private property rights?

A

The owner of the private property cannot prevent passers-by from enjoying the view of the house.

Passers-by can free-ride despite not paying for the good.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What is the free-rider problem?

A

A free rider is someone who benefits without paying as a result of non-excludability. Customers may choose not to pay for a good, preferring instead to free ride, with the result that the incentive to provide the good through the market disappears.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is the free-rider problem a cause of?

A

Market failure.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Why is the free-rider problem a cause of market failure?

A

There is a missing or partial missing market which means consumers / producers cannot charge for the damages (although they can in some instances) and public benefits they generate respectively.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is a production externality?

A

An externality generated in the course of producing a good or service.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is a production externality of a power station?

A

The power station discharges pollution into the atmosphere to produce electricity. The production externality is therefore negative. The power station evades some of the real costs of production by dumping the public bad onto others.

The price the consumer pays only reflects monetary costs of production, not all the real costs which include external costs.

In a market situation, the power’s station output of electricity is therefore underpriced. The allocative function of prices has therefore broken down.

The under-pricing of electricity encourages over-consumption of electricity, therefore leading to over-production of both electricity and pollution.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

How can a power station possibly have positive production externalities?

A

It can be assumed that the power station generates warm and clean water, which should increase fish stocks in a nearby river.

Therefore private anglers and commercial fishing boats benefit from the power station.

As the power station cannot charge the fishermen for the warm water, as not only do they not own the river, the fishermen are not paying for the warm water which they are fishing from.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What is a consumption externality?

A

An externality generated in the course of consuming a good or service.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What is an example of a negative consumption externality?

A

Going to a cinema and being disturbed by other cinema-goers eating loudly, or talking.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

What are the two types of externality?

A

Pure production externalities
Pure consumption externalities

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

How do externalities lead to the ‘wrong’ quantity of a good being produced and consumed?

A

If negative production externalities are gnerated, goods end up being too cheap or under-priced as the market has created the wrong incentives.

Prices under-reflect the true costs of production, including the cost of negative externalities so too much of the good end up being produced and consumed.

The opposite occurs when firms generate positive production externalities.
Prices end up being too high, so the ‘wrong’ quantity of the good is produced and consumed.
The market has created the wrong incentives, discouraging consumption.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

What is the Coase theorem and where can it be applied?

A

An argument that if markets can be created for private property rights, government intervention to correct market failures might be not necessary.

Coase used an example of wood-burning locomotives.
A more appropriate example for the modern world would be a loud factory producing machinery. As it is a loud process, the neighbours are disturbed, but the business can pay neighbours to compensate for the noise.

The Coase theorem has greatly influenced the free-market approach to market failures. Most economists now accept that govenrments should try to work with the market rather than against the market through regulation.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What do critics of private property rights tend to want?

A

The transfer of private property rights to government ownership.

Transfer to government ownership can take two scenarios, being:
government ownership
common ownership (no government control that aims to achieve the common good)

24
Q

What is the ‘tragedy of the commons’

A

A system in which individuals are incentivised to work in a way that will be ultimately harmful to all.

25
Q

What can the ‘tragedy of the commons’ lead to?

A

Potential overuse of a common-pool resource - hybrid between a public and private good - can also influence individuals to act with their short-term interest in mind, resulting in the use of an unsustainable product and disregard the harm it could cause to the environment or general public.

26
Q

What is a recent example of the ‘tragedy of the commons’?

A

The reduction of fish in the oceans and rivers due to overfishing.

Individual firms and fishermen are overfishing in the rivers but over time, the number of fish available falls and therefore less opportunity for fishermen to get an income.

Working in this manner becomes unsustainable.

27
Q

What are the main types of environmental externalities?

A

Pollution of land, sea, rivers or air.
Road usage, congestion.
Sulphur dioxide from power burning.

28
Q

How are governments attempting to reduce environmental market failures?

A

Increase behavioural nudges to reduce the dumping of plastic into rivers and oceans.

29
Q

What is the main assumption to do with economic agents?

A

They only consider private costs and benefits resulting from market actions, ignoring any social costs or benefits.

29
Q

What is the main assumption to do with economic agents?

A

They only consider private costs and benefits resulting from market actions, ignoring any social costs or benefits.

30
Q

When does private benefit maximisation occur?

A

Marginal Private Benefit (MPB) = Marginal Private Cost (MPC)

31
Q

When does social benefit maximisation occur?

A

Marginal Social Benefit (MSB) = Marginal Social Cost (MSC)

32
Q

What is social benefit maximisation?

A

When the public interest or welfare of the whole community is maximised.

33
Q

What does orthodox economic theory assume about households?

A

They seek to maximise their private benefit with no concern for their actions on the wider community.

34
Q

What does net social benefit not coincide with net private benefit?

A

As traditional economic theory assumes households only look to maximise individual benefit, they generate externalities, which causes net private benefit to diverge from net social benefit.

35
Q

What does net social benefit not coincide with net private benefit?

A

As traditional economic theory assumes households only look to maximise individual benefit, they generate externalities, which causes net private benefit to diverge from net social benefit.

36
Q

What is social benefit defined as (equation)?

A

Marginal Social Benefit = Marginal Private Benefit + Marginal External Benefit

MSB = MPB + MEB

37
Q

What is social cost defined as (equation)?

A

Private Cost + External Cost

MSC = MPC + MEC

38
Q

Draw the graph for a negative externality?

A
39
Q

What is the difference between the two curves in this graph called?

A

Marginal External Cost

40
Q

Where does the power station maximise private benefit?

A

Where MPC = MPB

41
Q

Where is the socially optimal level of output?

A

Where MSC = MSB

42
Q

How can deadweight loss be eliminated, and why does this occur?

A

At a free market output of Q1, the social cost of producing one unit of electricity is greater than the benefit society derives from eaech unit produced.

Society would be better off if units between Q2 and Q1 were transferred to the production of other products.

43
Q

Draw a positive production externalities graph.

A
44
Q

Why are there positive production externalities associated with planting trees?

A

Factors such as:
* Improved water retention in the soi
* Carbon sink to absorb global-warming gases

The factors themselves are unimportant for exams, but think about what the positive externalities are for whatever the given product is and name them.

45
Q

What does the vertical distance between the MPC and MSC mean in a positive production externalities graph?

A

A negative marginal external cost at each level of tree planting.

46
Q

Why should the deadweight loss be eliminated in a positive production externalities graph?

A

The marginal social benefit outweighs the marginal private cost until the point where MSB = MSC. i.e. the socially optimum point of production.

47
Q

When can allocative efficiency occur?

A
  • Competitive markets for all goods and services
  • No economies of scale
  • Markets were simultaneously in equilibrium.
  • When P=MC, there would have to be no externalities (negative or positive)
48
Q

Why can allocative efficiency never really occur?

A

It’s an abstract concept rather than a real-life concept.

49
Q

Where does profit maximisation occur in the long run according to externalities?

A

Where P = MPC.

Without externalities, P = MSC.

However, the production of almost all goods generate pollution or some other negative external costs, and as a result, MSC > MPC. Therefore, when P = MPC, P < MSC.

In order to achieve allocative efficiency, price must equal the true marginal cost of production which includes both marginal private cost and marginal SOCIAL cost.

However, firms are assumed to be profit-maximising and only take account of private costs so when externalities exist, the market fails to achieve an allocatively efficient outcome.

The firm evades part of the true cost of production by dumping the externality on third parties. The price the consumer pays reflects only the private cost of production therefore, the firm’s output is under-priced, encouraging too much consumption.

50
Q

When do externalities exist?

A

When there is a divergence between private and social costs or benefits.

51
Q

What is the key feature of externalities?

A

There is no market in which it can be bought or sold.

52
Q

Where are externalities produced and received relative to the market?

A

Outside the market.

Another missing market.

53
Q

What do externalities divide into?

A

Production externalities.
Consumption externalities.

54
Q

What effect do externalities have on production and consumption?

A

The ‘wrong’ quantity is consumed and produced.

55
Q

What happens to prices and consumption in negative production externalities?

A

Prices are too low.
Too much of the good is produced and consumed.

56
Q

What happens to prices and consumption in positive production externalities?

A

Prices are too high.
Not enough of the good is produced and consumed.