Chapter 11 | Externalities, Carbon Taxes, Free Riders and Public Goods

Question 1

Handcuffing the Invisible Hand: Market Failure with Externalities

Answer 1

When externalities exist, prices don’t reflect all social costs and benefits; markets fail to coordinate private smart choices with social smart choices.

Question 2

Negative externalities (external costs)

Answer 2

costs to society from your private choice that affect others, but that you do not pay.

Question 3

Positive externalities (external benefits)

Answer 3

benefits to society from your private choice that affect others, but that others do not pay you for.

Question 4

Externalities occur when clear property rights are missing.

Answer 4

– Tragedy of the commons — the overuse and depletion of a resource that no one can be excluded from because of missing property rights.
– Free riders — those who consume products or services without paying.

Question 5

When externalities exist, prices don’t reflect all social costs and benefits, and markets fail to produce efficient outcomes. Instead markets produce:

Answer 5

– too many products and services with negative externalities (second-hand smoke, pollution, traffic jams).
– too few products and services with positive externalities (vaccinations, education).

Question 6

Why Radical Environmentalists Dislike Economists: Efficient Pollution

Answer 6

For an efficient market outcome when there are negative externalities, choose the quantity of output where marginal social cost equals marginal social benefit.

Question 7

Efficient pollution” balances the additional environmental benefits of lower pollution with the additional opportunity costs of reduced living standards.

Answer 7

– The socially desirable amount of pollution is not zero; at some point the additional opportunity costs of reducing pollution are greater than the additional benefits of lower pollution.

Question 8

The market quantity and price are determined at the intersection of the marginal private benefit and marginal private cost curves.

Answer 8

The market quantity and price are determined at the intersection of the marginal private benefit and marginal private cost curves.

Question 9

For any product or service that generates an externality, the rule for a smart choice is: Choose the quantity of output where marginal social cost equals marginal social benefit.

Answer 9

– Marginal social cost
– Marginal external cost
- Marginal social benefit
– Marginal external benefit

Question 10

– Marginal social cost

Answer 10

(MSC) = marginal private cost (MC) plus marginal external cost

Question 11

– Marginal external cost

Answer 11

= price of preventing or cleaning up damage to others external to the original activity

Question 12

– Marginal social benefit (MSB)

Answer 12

(MSB) = marginal private benefit (MB) plus marginal external benefit

Question 13

Marginal external benefit

Answer 13

= price of the value or savings to others external to the original activity

Question 14

Markets overproduce products and services with negative externalities; the price is too low because it does not incorporate external costs.

Answer 14

Markets overproduce products and services with negative externalities; the price is too low because it does not incorporate external costs.

Question 15

Liberating the Invisible Hand: Policies to Internalize the Externality

Answer 15

If polluters are forced by government to pay the marginal external costs of their pollution, this internalizes the externalities/costs into private choices, creating smart social choices.

Question 16

Without property rights to the environment, businesses have incentives to save money and improve profits by ignoring external costs like pollution and global warming.

Answer 16

Without property rights to the environment, businesses have incentives to save money and improve profits by ignoring external costs like pollution and global warming.

Question 17

Governments can remedy market failures from externalities by creating social property rights to the environment, making polluting illegal, and penalizing polluters.

Answer 17

Governments can remedy market failures from externalities by creating social property rights to the environment, making polluting illegal, and penalizing polluters.

Question 18

Emissions tax

Answer 18

tax to pay for external costs of emissions
- Carbon Tax
- Smart Carbon Tax

Question 19

Carbon tax

Answer 19

emissions tax on carbon-based fossil fuels

Question 20

Smart carbon tax

Answer 20

= marginal external cost of damage from emissions

Question 21

Cap-and-trade system

Answer 21

— limits the quantities of emissions businesses can release into environment.

– Government auctions off pollution permits to the highest bidders.
– Total quantity of emissions allowed by permits = emissions target.
– Businesses buy and sell emissions permits. Permit price becomes a private cost to business reflecting the marginal external cost of pollution.

Question 22

Internalize the externality

Answer 22

— transform external costs into costs the producer must pay to the government.

Question 23

Carbon taxes and emissions permits give pollution a price reflecting marginal external cost of damage done, so smart individual and business choices become smart social choices.

Answer 23

Carbon taxes and emissions permits give pollution a price reflecting marginal external cost of damage done, so smart individual and business choices become smart social choices.

Question 24

Carbon taxes and cap-and-trade systems are smart policies for efficient pollution, but may be inequitable in hurting lower-income consumers most.

Answer 24

Carbon taxes and cap-and-trade systems are smart policies for efficient pollution, but may be inequitable in hurting lower-income consumers most.

Question 25

With positive externalities, buyers and sellers are not paid for the external benefits their exchange creates. The market-clearing price is too high for buyers to be willing to buy the socially best quantity of output, and too low for sellers to be willing to supply.

Answer 25

With positive externalities, buyers and sellers are not paid for the external benefits their exchange creates. The market-clearing price is too high for buyers to be willing to buy the socially best quantity of output, and too low for sellers to be willing to supply.

Question 26

Public goods

Answer 26

— provide external benefits consumed simultaneously by everyone; no one can be excluded.

– Public goods like lighthouses and national defence are extreme examples of positive externalities.

Question 27

Free-rider problem

Answer 27

— markets underproduce products and services with positive externalities.

– Price charged to buyers is too high.
– Price received by sellers is too low.

Question 28

The smart social quantity of output with positive externalities is at the intersection of the marginal social benefit and marginal social cost curves.

Answer 28

– With positive externalities, no single price can coordinate smart individual choices and smart social choices.
– The market-clearing price is too high for buyers to be willing to buy and too low for sellers to be willing to supply.

Question 29

Why Your Tuition Is Cheap (Really!): Subsidies for the Public Good

Answer 29

When there are positive externalities, government subsidies can get everyone to voluntarily choose the socially best quantity of output where marginal social benefit equals marginal social cost.

Question 30

Subsidy

Answer 30

— payment to those who create positive externalities.

– Smart subsidy = marginal external benefit of savings to others associated with an activity.
– Subsidies remove the disconnect between prices for buyers and sellers caused by positive externalities, leading individuals and businesses to voluntarily choose the quantity of output best for society.
– Subsidies to either suppliers or demanders can achieve an efficient social outcome.

Question 31

Public provision

Answer 31

— government provision of products or services with positive externalities, financed by tax revenue.