Chapter 18 - Externalities

Question 1

What are externalities?

Answer 1

a cost or benefit imposed without compensation on someone other than the person who caused it

Question 2

What is a private benefit?

Answer 2

that accrues directly to the decision maker

Question 3

What are external benefits?

Answer 3

benefits that accrues without compensation to someone other than the person who created it (positive externality)

Question 4

What is a private cost?

Answer 4

cost that falls directly on an economic decision maker

Question 5

What are external costs?

Answer 5

a cost imposed without compensation on someone other than the person who caused it (negative externality)

Question 6

What are social costs?

Answer 6

the entire cost of a decision, including both private and external costs

Question 7

What is a social benefit?

Answer 7

the entire benefits of a decision, including both private and external benefits

Question 8

What is a network externality?

Answer 8

the effect that an additional user of a good or participant in an activity has on the value of that good or activity for others

Question 9

What is a negative externality?

Answer 9

causes the individual who bear only the private cost to demand or supply an inefficiently high quantity at any given price

Question 10

What is a positive externality?

Answer 10

causes the individuals who enjoy only the private benefit to demand or supply an inefficiently low quantity at any given price

Question 11

What is the Coase theorem

Answer 11

if there are zero transaction costs to negotiate and agreements are enforceable, then an efficient equilibrium through private trades can be reached, even in the presence of an externality.

• people can make contracts to pay one another

Question 12

What is a pigovian tax?

Answer 12

counters the effects of a negative externality

eg. carbon taxes, sin taxes (alcohol and cigarettes)

Question 13

What are the two main problems with the pigovian tax?

Answer 13

• setting the tax at the right level

- no guarantee that the government can or will do anything to help people bearing the external cost

Question 14

What is a subsidy?

Answer 14

counters the effects of a positive externality

Question 15

What are the two main problems with a subsidy?

Answer 15

• setting the subsidy at the right level

- no guarantee that the government gets the money from a “fair” source

Question 16

What happens in the presence of externalities?

Answer 16

markets fail to maximize total surplus