Chap. 11 - Externalities

Question 1

What is an externality?

Answer 1

An external benefit or cost that is enjoyed or imposed on a third party other than the buyer or seller of the good.

Question 2

Give some examples of negative externalities.

Answer 2

Examples of negative externalities include various forms of pollution, such as air pollution from factories or power plants, water pollution; noise pollution such as airports or even roommates; and drivers who are impeded by drugs, alcohol, or texting.

Question 3

When there are externalities is marginal private cost the same as marginal social cost?

Answer 3

No, The marginal social cost adds to the marginal private cost the cost of the externality, which graphically is the vertical distance between the marginal private cost and marginal social cost.

Question 4

Describe the graph when there is a negative externality.

Answer 4

On the axis is price and on the x axis there is quantity. There is a downward sloping Demand Curve that is equal to Marginal Benefit. S1 is an upward sloping supply curve showing the marginal private cost of the firm. There is another upward sloping supply curve, S2 which is the marginal social cost which is above S1. The difference between S1 and S2 is the negative externality. The firm produces where MPB = MPC, but there is deadweight loss to society in the form of the negative externality.

Question 5

Give an example of a negative production externality and a negative consumption externality.

Answer 5

Negative production externalities are generated when the good or service is produced such as factories polluting the air, water or land as they produce the good or service.
Negative consumption externalities occur when the consumption of the good or service creates the externality, for example an individual that consumes alcohol at the bar then, when driving home, kills pedestrians due to his impairment.

Question 6

What is the tragedy of the commons?

Answer 6

In some college apartments, dishes pile up in the sink or the garbage doesn’t get taken out, because it belongs to everyone collectively and no one individually. When a resource belongs to everyone, individuals account only for the private marginal benefits and costs and fail to account for the impact of their actions on others.

Question 7

What is a positive externality and what are some examples?

Answer 7

When a positive externality is present, the market produces less than the socially optimal quantity of the good or service, since there is a benefit to society that is not captured by the individual. Education,immunizations

Question 8

Describe the graph when there is a positive externality.

Answer 8

Price is on the y axis, and quantity is on the x axis. Downward sloping demand curve = marginal private benefit, D1. And upward sloping supply curve which is marginal cost, S1. D2 wich is above D1 is downward sloping demand which is equal to the marginal social benefit, and the difference between D1 and D2 is the positive externality. There occurs a deadweight loss between D1 and D2 equilibrium points.

Question 9

How can externalities be controlled?

Answer 9

Through Command and Control options, which are usually legislation, or regulatory bodies monitoring the behavior of the industry.

Question 10

What can governments do to get rid of externalitites?

Answer 10

Governments can levy a tax equal to the negative externality, or they can provide a subsidy equal to the positive externality.

Question 11

Since private goods are rival, excludable, and divisible what does that mean?

Answer 11

By “rival” we mean that the consumption of the good or service by one prevents another from consuming the item. Excludable means that those who do not pay for the good or service, cannot consume it. Finally, private goods are divisible meaning the production of the good or service can be divided among those who are consuming the good.

Question 12

What is a Public Good, give some examples

Answer 12

Pure public goods are nonrival, nonexcludable, and nondivisible.
National Defense, Lighhouses

Question 13

Goods can be classified in one of four different categories, what are they?

Answer 13

Private, common resources, quasi-public goods, and public goods

Question 14

What are some examples of quasi-public goods and common resources?

Answer 14

Toll Road, Cell Phones

Ocean Fishing, Public Lands

Question 15

When trying to determine the value of a public good, what is one major problem?

Answer 15

If individuals are concerned about the amount they will be taxed to provide or protect a good, their stated value may not reflect their true value

Question 16

What is a Cost/Benefit analysis? How does it work?

Answer 16

Benefit/Cost analysis weighs the benefits of a project to the costs of a project. Since benefits and costs may occur at different time periods, we convert future values to a present value for a common comparison. To compute the present value of a future benefit or cost, the future value is divided by (1+r)t, where r is the interest rate expressed as a decimal and t is the number of years until the benefit or cost is incurred.

Question 17

What is the Future and Present value equations?

Answer 17

PV = FV/(1+r)^t
FV = PV * (1+r)^t

Question 18

What is adverse selection and moral hazard? Give an example of each.

Answer 18

Adverse selection can arise when information is known to one party in a transaction that is not known to the other, at the time the contract is made. A used car, is it a lemon?
Moral hazard occurs when the behavior of one changes after the contract is made. I get a loan for a house and then go to Vegas.