Chapter 18 and 19 Flashcards
What are externalities?
A situation in which the costs of an action are not fully borne by the two parties engaged in exchange.
A situation in which a private cost diverges from a social cost.
Externalities can be external costs and external benefits
What are external costs?
Private cost:
Costs borne by the individuals who incur them.
External cost: Any other cost that is imposed without compensation on someone other than the person who incurred it.
Social cost: Add private costs to external costs
What are external benefits?
Private benefits: Benefits that accrue directly to the decision maker
External benefit: Accrues without compensation to someone other than the person who caused it
Social benefit: Add private and external benefits
What are externalities? Pt.2
Network externality- effect that an additional user of a good or participant in an activity has on the value of that good or activity for others
- Network externalities imply that people can help or harm others simply by participating in a group
Negative Network externality
Examples:
1) Every additional user trying to use Yellow Head during rush hours.
2) When additional user of a wireless internet slows the connection.
Positive Network externality
Examples:
1) The use of telephone when other people are using it
2) the use of Facebook, LinkedIn, Twitter when others are using them.
What are externalities? Pt.3
Negative production externality- external cost when good or service is being produced
Example: Pollution in auto industry as a result of car manufacturing.
Negative consumption externality - third-party cost when a good or service is being consumed
Example: Passive smoking, inhalation of smoke exhaled by an active smoker.
Negative Production Externality?
Private equilibrium - 10 million cars made at a price of $20,000 each
Creates a deadweight loss due to externality
If externalities are accounted, 8 million cars made at a price of $22,000
What are externalities: Positive consumption externality?
Positive consumption externality:
- Third-party benefit when a good or service is consumed
Positive production externality:
- Third-party benefit where a good or service is being produced
Example: The power plant in Florida uses cold water from the ocean and remits warm water back to the ocean and this helps the population of Manatee to grow more
Private solution to externalities?
Coase theorem:
- Individuals can reach an efficient equilibrium through private trades, even in the presence of an externality
- There is low transaction costs.
Example: Pay Brazilian logging companies to maintain the rainforest.
Note: In reality, individuals may not pay polluters to stop pollution, so Coase theorem may not work.
Public solution to externalities?
Pigouvian tax – Is revenue collected by the government. (e.g. tax on alcohol, cigarette, gasoline)
Subsidies- Counter the effects of under production. (e.g. If government decides to give $500 subsidy to people who paint their houses, people may be encourage to paint their houses.)
Quotas- Setting limitation on the amount of something.
(e.g. imposing limitation on the quantity of pollution.)
Tradable allowance - Production or consumption quota that can be bought and sold
Example: Cap and Trade Programs: allow the polluter to sell any excess allotment to another polluter.
Some Extra Notes on subsides?
Using subsidy to increase efficiency does not necessarily equal fairness
Subsidy would maximize total surplus in society, but distributionof surplus depends on where government gets the money to pay for the subsidies
Limiting consumption to efficient quantitydoes notmake the market efficient; resources end up allocated to those most willing to pay for them
Maximizing surplus depends not only on volume manufactured, but also onwhomanufactures them
Tax allows market to sort itself out in this way; a quota does not.
Tradable allowances result in efficient quantity of a good being bought and sold and maximizes surplus
Tradable allowance creates a market in which quota rights are bought and sold amongprivate parties
Four categories of goods?
Private goods - goods that are both excludable and rival
usually allocated efficiently by competitive markets
Public goods - neither excludable nor rival
Common resources - goods that are not excludable but are rival
Artificially scarce goods - excludable, but not rival (e.g. Streaming Netflix movies)
Examples: Street Lights, Park, Sandwich and Fries
Characteristics of goods?
If a good isexcludable, it is possible for sellers to prevent its use by those who have not paid for it
If a good isrival in consumption(or justrival), one person’s consumption prevents or decreases others’ ability to consume it
Examples: Electronics, Kitchen Wares, Soft Drinks
Excludability allows owners to set an enforceable price on a good
- When a good is not easily excludable, what people pay for it will not necessarily reflect the real value they place on it
Rivalry has to do with whether or not a good is “used up” when someone consumes it
Public Goods Continued?
Free-rider problem:
- Problem that occurs when the non-excludability of public good leads to undersupply
- Given the opportunity, people will free-ride; enjoy positive externalities from others’ choices to pay
- It leads to market failure.
Market failure- situations in which the actions of private individuals and firms areinsufficient to ensure efficient markets.
Public Goods Continued Solutions?
Solutions to free-rider problem:
1) Change social norms related to the good or service
- Strong social norms can help rebalance the trade-off by imposing social costs on people
2) Government Provision: Assign responsibility to provide a quantity of good or service (e.g., municipal snow plowing on public roads)
3) Make good or service more excludable by assigning property rights (such as the pay-per-use public toilets found in some big cities)
Public Goods Continued? Pt.2
Public goods are undersupplied
Common resources are over-consumed
Tragedy of the commons
- The depletion of common resources due to overconsumption.
Solutions to the tragedy of the commons:
1) Social norms - discipline, integrity requiring
- Clear distinctions between who is and is not allowed to access the resource
- Participation of resource users in setting rules for use
- Ability of users to monitor one another
2) Bans/quotas: often fail where it is difficult/costly for authorities to monitor and punish rule breakers
- Common resources are not allocated efficiently by markets, but private goods are
3) Tradable Allowances:
- Cap set on quantity of resource that can be used
- Shares of that total allocated to individuals or firms
- After allocation, people can buy and sell their shares, ensuring resource allocated to highest payers while still limiting overall quantity to an efficient level
