chapter 8 Flashcards
market failures
There are important cases in which markets fail to allocate resources efficiently and maximize social surplus.
An externality arises when
a person engages in an activity that influences the well-being of a bystander but neither pays nor receives compensation for that effect
there are four types of externalities:.
- Negative production externality
• Industrial production leads to pollution and carbon emissions - Positive production externality
• Innovation leads to new technologies - Negative consumption externality
• Car driving leads to pollution, congestion, accidents - Positive consumption externality
• Vaccination leads to immunization
people are internalizing the externalities.
When individuals or firms take into account the full costs and benefits of their actions
Coase’s idea:
If the allocation with externalities is inefficient, why can’t the affected parties to an externality bargain over outcomes until the efficient outcome is reached?
The Coase theorem (part I)
When there are well-defined property rights and costless bargaining, negotiations between the party creating the externality and the party affected by the externality can bring about the socially optimal market quantity
The Coase theorem (part II)
The efficient solution to an externality does not depend on how the property rights are assigned. It just needs the property rights to be assigned somehow.
Understanding the Coase theorem
An efficient outcome can be reached given:
- low negotiation costs (referred to as transaction costs, the costs that parties incur in the process of agreeing and following through on a bargain)
- clear assignment of property rights
Two types of government policies:
- Command and control policies: Regulation
• regulate behavior directly.
• Imposing an emission standard or maximum level of pollution that a factory may emit.
• Mandatory adoption of a particular technology to reduce emissions. - Market based policy: Taxes
• Taxes align private incentives with social efficiency.
• Taxes enacted to deal with the effects of negative externalities are called corrective taxes or Pigovian taxes (Arthur Pigou).
An emission standard
is a maximum level of pollution that a factory may emit.
An emission tax is… and gives …
- is a tax that firms have to pay for each unit of emission.
- gives factory owners an incentive to reduce pollution.
Cap-and-trade policy
• The government determines the total level of pollution allowed in a market (= the cap) and makes an initial distribution of the cap across firms and allows them to trade in a market for pollution permits.
