6. Chapter 10

Question 1

What is an externality?

What are positive and negative externalities?

Answer 1

Externalities are the uncompensated impact of one persons actions on the well being of a bystander
Positive externality is one that has a beneficial effect on the bystander (restored historic buildings- they look good to people passing by)
Negative externality has an adverse effect on the bystander (exhaust creating smog)

Question 2

What is social cost?

Answer 2

For example, a company pollutes smoke when creating their product, the cost to society is greater than the cost to the producer
Social cost is the private costs of producers plus the costs to those bystanders affected by pollution
Page 202 graph

Question 3

What would the benevolent social planner choose for production with a supply curve, demand curve, and negative externality social-cost curve?

Answer 3

The planner would pick the level of output at which the demand curve crosses the social-cost curve
Page 202 graph

Question 4

How is deadweight loss found on a negative externality graph?

Answer 4

It is the triangle formed to the right of the social cost curve and supply curve intersection but stops at the equilibrium quantity
Also known as reduction in total surplus
Page 203 study graph and table

Question 5

What is internalizing the externality?

Answer 5

Alter incentives so that people take account of the external effects of their actions
Gives buyers and seller incentive to take into account the external effects of their actions

Example: taxing an aluminum production company for every time of aluminum sold since they pollute
Or subsidy’s on education for positive externalitys

Question 6

Where is the optimal quantity found on a positive externality graph?

Answer 6

Where the social value and supply curve (private cost) intersect
Page 205 graph

Question 7

What do negative externalities lead markets to do?

What about positive externalities?

Answer 7

Negative externalities lead markets to produce a larger quantity than is socially desirable
Positive externalities lead markets to produce a smaller quantity than socially desirable
To fix the problem, the government internalizes the externality by taxing goods that are negative and subsidizing good that are positive

Question 8

What are command and control policies?

Answer 8

Regulation

Governments can remedy an externality by making certain behaviours either requires or forbidden

Question 9

What are corrective taxes and subsidies?

Answer 9

Instead of regulating behaviour, government can you market based policies to align private incentives with social efficiency
Taxing negative externalities (corrective or pigovian taxes) and subsidizing positive

Question 10

What would an ideal corrective tax do?

What about an ideal corrective subsidy?

Answer 10

An ideal corrective tax would equal the external cost from an activity with negative externalities
An ideal corrective subsidy would equal the external benefit from an activity with positive externalities

Question 11

Why do economists prefer corrective taxes over regulations?

Answer 11

Taxes can reduce pollution at a lower cost to society
Regulation dictates a level of pollution while tax give factory owners an economic incentive to reduce pollution
Example on page 208 1/3 from top

Question 12

What are the 3 reasons gasoline is taxed so high?

Answer 12

1. Congestion- avoiding bumper to bumper traffic
2. Accidents
3. Pollution

Question 13

What are pollution permits?

Answer 13

Firms making deals with how much pollution they have the right to produce
Paper mill producing less pollution if steel mill pays them to make more product with more pollution
The more costly it is for a firm to cut back on pollution, the more it will be willing to pay for a permit

Question 14

What are the similarities between pollution permits and corrective taxes on pollution?

Answer 14

Firms pay for pollution
Both internalize the externality you pollution by making it costly for firms to produce
Corrective tax sets the price for pollution which is a perfectly elastic supply curve
Pollution permits set the quantity of pollution with a perfectly inelastic supply curve
Graph on page 212

Question 15

What are the types of private solutions to externalities?

Answer 15

1. Moral codes and social sanctions- littering is just not the right thing to do
2. Charities- organizations that help the world
3. Can solve problems by relying on self interest of the relevant parties- one business buying another business associated with that product (page 214 top example)
4. Interested parties enter a contract- instead of buying the other business both business can agree on what they want

Question 16

What is the Coase theorem?

Answer 16

The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own
Tells how effective the private market is in dealing with externalities
Example on page 214 bottom
Essentially private economic actors can solve the problem of externalities among themselves. Whatever the initial distribution of rights, the interested parties can reach a bargain in which everyone in better off and outcome is efficient.
This rarely works in real world tho

Question 17

What are transaction costs?

Answer 17

The costs that parties incur in the process of agreeing to and following through on a bargain
Reason interested parties fail to solve an externality problem
Page 215 Example

Question 18

When does the government step in to solve externalities?

Answer 18

When people cannot solve the problem of externalities privately