Econ 101: Chapter 10 Flashcards
Externality
a side effect of an activity that affects bystanders whose interests aren’t taken into account.
Externalities lead to…
market failure, producing inefficient outcomes that aren’t in society’s best interest.
negative externality
an activity that imposes costs onto bystanders
positive externality
activities that generates benefits for bystanders
price changes are not…
an externality
private interest
the costs and benefits you personally incur.
society’s interest
includes all costs and benefits, whether they accrue to you or to others.
marginal private costs
the extra cost paid by the seller from producing one extra unit.
external cost
a cost imposed on bystanders
marginal external cost
the extra external cost imposed on bystanders from producing one extra unit.
marginal social cost
all marginal costs, no matter who pays them (marginal external cost + marginal private cost).
marginal private benefit
the extra benefit enjoyed by the buyer from one extra unit
external benefit
the benefit enjoyed by bystanders, created by positive externalities
marginal external benefit
the extra external benefit enjoyed by bystanders from the extra unit.
marginal social benefit
all marginal benefits, no matter who gets them (marginal private benefit + marginal external benefit).
A seller’s supply curve is described by their…
marginal private costs.
a buyer’s demand curve is described by their…
marginal private benefits.
Socially optimal outcome
the outcome that is most efficient for society as a whole, including the interest of buyers, sellers, and bystanders.
Rational Rule for Society
produce more of an item as long as its marginal social benefit is at least as large as the marginal social cost.
negative externalities lead to…
overproduction
positive externalities lead to…
underproduction
6 solutions to externality problems:
private bargaining / coase theorem, corrective taxes & subsidies, cap & trade, laws/rules/regulations, government support for public goods, and assignment of ownership rights.
Private bargaining
get all interested parties together, and give them a chance to negotiate.
side payment
if someone else’s actions harm you, you can pay them to do something else instead (negative externalities).
Also works with positive externalities.
Coase Theorem
if bargaining is costless and property rights are clearly established and enforced, then externality problems can be solved by private bargains.
Private bargaining solves externality problems…
when the bargaining costs are low.
Corrective taxes
aka Pigouvian tax
a tax designed to induce people to take account of the negative externalities they cause.
Impose a corrective tax…
the size of the marginal external cost
corrective subsidies
incentivizes people to do more of the things that ocnfer marginal external benefits onto others.
create a corrective subsidy…
the size of the marginal external benefit.
Cap and trade
Involves changing the quantity of the harmful directly, through a quantity regulation.
set the quota at…
the socially optimal outcome
in a cap and trade…
a fixed number of permits are allocated, which can then be traded.
the cap and trade system is like…
a corrective tax – raises opportunity costs.
laws/rules/regulations
exist to solve problems caused by negative externalities.
Rules and regulations can be…
a blunt instrument
Rules that specify how to achieve a given objective…
are inefficient.
This reduces the incentive to innovate and find a better more efficient method.
non-excludable
when someone cannot be easily excluded from using something.
nonrival
a good for which one person’s enjoyment or use of it doesn’t subtract from another person’s enjoyment or use.
rival
a good for which your use of it comes at someone else’s expense.
public good
a nonrival good that is nonexcludable and hence subject to the free-rider problem.
free rider problem
when someone can enjoy the benefits of a good without bearing the costs.
club good
good that is excludable, but non-rival in consumption
underprovided by businesses.
public goods create…
positive externalities, as people can’t be forced to contribute as they can’t be excluded from enjoying the good.
government support for public goods
Governments can solve the underprovision of public goods by purchasing them for everyone to use with tax revenue.
fact 1 about public goods.
- not all gov’t provided goods/services are public
fact 2 about public goods.
- not all public goods should be/are funded by gov’t.
fact 3 about public goods.
- just because a government funds a public goods doesn’t mean they should provide it – they can hire a private firm.
common resources
a good that is rival and also nonexcludable.
-private gains but shared costs.
tragedy of the commons
a tendency to over consume a common resource.
Assigning ownership rights…
can solve common resource problems (tragedy of the commons).
the owner will facilitate successful private bargaining.
