eco105: 11-12 Flashcards
Negative externalities
costs to society from your private choice that affect others, but that you do not pay
Social costs =
private (opportunity costs) + external (opportunity) costs
Positive externalities
benefits to society from your private choice that affect others, but that others do not pay for
Social benefits =
private benefits + external benefits
Free riders
people who consume products or services without paying
Why do businesses produce too few products and services with positive externalities
Because free riders do not have incentives to pay us for the external benefits
When do externalities occur?
when clear property rights are missing
What happens without property rights
you have no incentive to produce for exchange because customers could take your work for free
How is the tragedy of the commons a negative externality problem
Adding your cow/sheep to the commons to eat the grass makes it harder for other animals to find grass to eat
Tragedy of the Commons
The tragedy of the commons was the overuse and depletion of the resource, the destruction of a common good
The grassland was overused and the grass would not regrow
How does the invisible hand help markets
helps markets coordinate private smart choices to be smart choices for society as a whole when prices adjust to reflect all costs and all benefits
What do economists think about pollution?
some level of pollution is “efficient”; there is a smart choice that balances the costs of a lower standard of living against the benefits of lower pollution
Efficient pollution
balances the additional environmental benefits of lower pollution with the additional opportunity costs of reduced living standards
Marginal social cost
marginal private cost (MC) plus marginal external cost
The rule for an efficient combination of output and pollution
Choose the quantity of output where marginal social cost = marginal social benefit (MSC = MSB)
What happens to social costs when there are negative externalities
- social costs are greater than private costs
- marginal social cost = marginal private cost directly paid by producers (MC) + marginal external cost imposed on others
Marginal social benefit
marginal private benefit (MB) plus marginal external benefit
What happens to social benefits when there are positive externalities
- Social benefits are greater than private benefits
- marginal social benefit = marginal private benefit directly received by consumers + marginal external benefit enjoyed by others
Market outcome
the intersection of the marginal private benefit and marginal private cost curves
Smart social choice
intersection of the marginal social benefit and marginal social cost curves
The rule for a smart social choice
choose the quantity of output where marginal social cost = marginal social benefit
How do governments support the invisible hand
set the environmental rules of the game in a way that aligns smart private choices with smart social choices → Create property rights (pollution laws)
two policies that force polluters to pay the cost of preventing or cleaning up the external damage they cause to others
Carbon Taxes and Cap-and-Trade System
Carbon tax
emissions tax on carbon-based fossil fuels
Emissions tax
tax to pay for external costs or emissions
A smart carbon tax is set at
an amount equal to the marginal external cost of the damage associated with the product
Internalize the externality
transform external costs into costs the producer must pay to the government
Cap-and-trade system
system that limits the quantity of emissions businesses can release into environment. (e.g businesses must have permits to pollute)
common objection to the cap-and-trade system
it allows businesses to “buy a license to pollute”
How does the carbon tax work
anyone using energy pays the tax up front
A carbon tax makes the cost of a negative externality directly obvious to consumers and businesses
How does a cap-and-trade system work
businesses pay initially for emissions permits, but consumers pay eventually as the additional cost is passed on in higher prices for products and services
The cost of emissions permits in a cap-and-trade system are far less obvious to the final consumer
3 shared benefits government policies to internalize the externalities of pollution have
- As carbon-based energy becomes more expensive, less carbon-based energy will be consumed– the law of demand applies: when something gets more expensive, people economize on its use and look for substitutes
- Carbon taxes and emissions-permit auctions raise revenues that can be used by government to repair the environmental damage, or for other environmentally friendly initiatives
- Higher carbon-based energy prices makes solar, wind, and hydro power more competitive, and encourage businesses to search for alternative energy sources
Public goods
provide external benefits consumed simultaneously by everyone; no one can be excluded
Free-rider problem
markets underproduce products and services with positive externalities
why do markets avoid producing public goods
no business can make a profit for them
How can a market fail due to positive externalities
Markets underproduce products and services with positive externalities: For the socially best quantity output, the market-clearing price is too high for buyers to be willing to buy and too low for sellers to be willing to supply
2 policies that get everyone to voluntarily choose the quantity of output where marginal social benefit = marginal social cost
subsidies and public provision
Subsidy
payment to those who create positive externalities, opposite of taxes
smart subsidy =
marginal external benefit
What does a subsidy do to suppliers
increases supply
Public provision
provision of products or services with positive externalities, financed by tax revenue
When do governments resort to public provision
when positive externalities are widespread and important for citizens, and/or when it is difficult to collect revenues from users
Input markets
businesses buy from households the inputs they need to produce products
In exchange, businesses pay households wages, interest, rent and other money rewards (households sellers, businesses are buyers)
Output markets
businesses sell their products to households
In exchange, households use the money they have earned in input markets to pay businesses for these purchases (households are buyers, businesses sellers)
Labour
price is the wage you receive, quantity is the number of hours you worked; determined by marginal revenue product
Capital
physical or financial resources used to produce value in an economy
determined by present value
Land
you can rent out land to get income; determined by economic rent
Flow
amount per unit of time, income is a flow
Stock
fixed amount at a moment in time, wealth is a stock
Income is what you ___, while wealth is what you ___
earn, own
Entrepreneurs’ Income
Economic profits, aka reward for innovation and risk-taking
Income depends on
prices and quantities, which depend on demand and supply (in input markets)
in an input market what are businesses and what are households
Businesses are now demanders and households are the suppliers
What must a business do to hire any input
a business must pay a price that matches the best opportunity cost of the input owner
Derived demand
demand for output and profits businesses can derive from hiring labour
Marginal product
additional output from hiring more unit of labour
Count only additional benefits and additional costs
Diminishing marginal productivity
marginal product is decreasing as the input increases holding other inputs constant
Marginal revenue product
additional revenue from selling output produced by an additional labourer
Marginal revenue product formula
marginal product x price of output
Marginal revenue products ___ as businesses add more workers
diminish
Recipe for Profits for Hiring Inputs
Hire additional inputs when marginal revenue product is greater than marginal cost
Present value
current value of a future sum of money
Present value formula
Amount of Money Available in n years/(1 + interest rate)^n
If the present value is greater than the price of the investment
smart choice
Discount
reduction of future revenues for forgone interest
Economic rent
income paid to any input in relatively inelastic supply
For inputs (like land) in inelastic supply, ___ output prices cause ___ input prices (economic rents)
high, high
Average market income for all Canadian families in 2010
$63.4K
One way statisticians measure inequality
calculating what percentage of total income earned in Canada is earned by each quintile
Human capital
economic value of a worker’s experience and skills
Low-income families
defined as those who spend at least one-fifth more of their income than the average family on the basic necessities of food, shelter and clothing
Progressive taxes
tax rate increases as income increases
Regressive taxes
tax rate decreases as income increases
Proportional (flat-rate) taxes
tax rate is the same regardless of income
Marginal tax rate
rate on additional dollar of income
Transfer payments
payments by government to households
conservative politician: taxes
oppose progressive taxes and transfers because they believe the efficiency of markets is more important for generating the economic prosperity that will help the poor
left-leaning politician taxes
favour progressive taxes and transfers because they believe equal outcomes are more important than efficiency
Effects of Income Redistribution on Incentive
reduces the incentives you have to provide inputs and produce outputs
