6: Externalities

Question 1

Externality

Answer 1

the uncompensated impact of one person’s actions on the wellbeing of another person.

• If the impact on a bystander is adverse, we have a negative externality
• If the impact on a bystander is beneficial, we have a positive externality

Question 2

EXAMPLES of Negative Externalities

Answer 2

• Pollution
• Cigarette Smoking
• Violating Lockdowns during pandemic

Question 3

EXAMPLES of Positive Externalities

Answer 3

• Vaccinations
• Restored Historic Buildings
• Research into new tech

Question 4

Solution to negative externality

Answer 4

Internalising the externality: Altering incentives so that buyers/sellers take into account all the effects of their actions.
In this case, a possible solution is to introduce a tax on each unit of aluminium traded

Question 5

NEGATIVE Externalities GENERAL RULE

Answer 5

Negative externalities lead markets to produce a larger quantity than is socially desirable

The government can remedy this by taxing goods that have negative externalities (internalising the negative externality)

Question 6

POSITIVE Externalities GENERAL RULE

Answer 6

Positive externalities lead markets to produce a smaller quantity than is socially desirable

The government can remedy this by subsidising goods that have positive externalities (internalising the positive externality)

Question 7

Private Solutions to externalities

Answer 7

• Moral codes and social sanctions
• Private donations (private version of government subsidies)
• Contracts

Question 8

Coase Theorem

Answer 8

If private parties can bargain without cost over the allocation of resources, they can reach agreements or bargains that solve the problem of externalities on their own (without government intervention).

Question 9

2 Reasons private solutions don’t always work

Answer 9

1. Transaction Costs

2. Large numbers of people involved

Question 10

2 Market Based Policies

Answer 10

1. Corrective Taxes and Subsidies

2. Tradeable Permits