Economics Chapter 11

Question 1

What is an externality

Answer 1

An externality is an uncompensated impact of one person’s actions on the well-being of a bystander

Question 2

What do externalities do to markets?

Answer 2

Externalities cause markets to be inefficient, and so fail to maximise total surplus

Question 3

Positive vs Negative externality

Answer 3

When the impact on the bystander is adverse, the externality is called a negative externality.
When the impact on the bystander is beneficial, the externality is called a positive externality

Question 4

What are market decisions based on?

Answer 4

Market decisions are based on weighing up private costs and private benefits

Question 5

Types of Externalities

Answer 5

Negative Externalities
Car exhaust fumes
Cigarette smoking
Barking dogs (loud pets)
Loud stereos in an apartment building
Positive Externalities
Immunisations
Restored historic buildings
Research into new technologies

Question 6

The market for aluminium

Answer 6

For each unit of aluminium produced, the social cost includes the private costs of the producers plus the cost to those bystanders adversely affected by the pollution

Question 7

Internalising an externality

Answer 7

involves altering incentives so that people take account of the external effects of their actions

Question 8

Achieving the socially optimal output

Answer 8

The government can internalise an externality by imposing a tax on the producer to reduce the equilibrium quantity to the socially desirable quantity

Question 9

Positive externalities

Answer 9

The social value of the good exceeds the private value
Education yields positive externalities.
A better-educated population leads to improved productivity and economic growth. The economic growth is the positive externality as it benefits everyone.
The marginal social benefit (MSB) is the private value plus the external benefit to society at each price

Question 10

What can subsidies be used for?

Answer 10

Subsidies can be used to attempt to internalise positive externalities

Question 11

Patent laws

Answer 11

Patent laws give the individual (or firm) with patent protection a property right over its invention.
Without property rights there would be less research

Question 12

Property rights

Answer 12

Property rights provide the exclusive right of an individual, group or organisation to determine how a resource is used(basically negotiate what you own with people who want to do something with it)

Question 13

What is a technology spillover?

Answer 13

A technology spillover is a type of positive externality that exists when a firm’s innovation or design not only benefits the firm but enters society’s pool of technological knowledge and benefits society as a whole

Question 14

Positional goods

Answer 14

Positional goods have the characteristic that the satisfaction derived from consuming such a good is dependent on how it compares with goods in the same class(some cars considered to be better quality)

Question 15

A positive externality

Answer 15

A positional externality is a situation which exists when the payoff to one individual is dependent on their relative performance to others(investors earn more than people

Question 16

A positional arms race

Answer 16

A positional arms race is a situation where individuals invest in a series of measures designed to gain them an advantage but which simply offset each other(individuals investing time and resources in gaining required qualifications and skills)

Question 17

Types of private solutions

Answer 17

1)Social norms and Moral Behaviour
Driven by moral codes and social sanctions
Do unto others as you would have them do unto you
Internalise externalities
2)Charities that deal with externalities
3)Self-interest
two firms confer positive externalities on each other or gain from each other’s presence
Internalisation of externalities
4)Social Contracts
Affected or interested parties enter into a contract

Question 18

The coase theorem

Answer 18

The Coase Theorem is a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own

Question 19

Why Private Solutions Do Not Always Work

Answer 19

Transactions Costs
Bargaining problems
Difficult to coordinate the interested parties
Asymmetric information and irrational behavior

Question 20

Transaction costs

Answer 20

Transaction costs are incurred in the process of agreeing to and following through on a bargain.
Sometimes the private solution approach fails because transaction costs can be so high that private agreement is not possible

Question 21

Bargaining problems

Answer 21

Sometimes bargaining simply breaks down.
Each party tries to hold out for a better deal

Question 22

Asymmetric information and irrational behavior

Answer 22

Buyers not knowing the costs and benefits in their situation
Free riding from other neighbors
Irrational behavior

Question 23

Public policies toward externalities

Answer 23

Gov may attempt to solve problem through
Command-and-control policies
Market-based policies

Question 24

Command and control policies

Answer 24

Usually take the form of regulations:
Forbid certain behaviors
Requirements that all students be immunized
Needs good information on specific industries and possible alternative technologies

Question 25

What can the government do to align private incentives with social efficiency

Answer 25

Government can internalize an externality be taxing activities associated with a negative externality and subsidise activities associated with a positive externality

Question 26

Pigovian taxes

Answer 26

Pigovian taxes are taxes enacted to correct the effects of a negative externality

Question 27

Marginal abatement cost

Answer 27

Marginal abatement cost – the cost of the last unit of pollution not emitted (abated

Question 28

Regulation vs Pigouvian Tax

Answer 28

Tell the firm to reduce its pollution by a specific amount (i.e. regulation).
Levy a tax of a given amount for each unit of pollution the firm emits (i.e. Pigouvian tax).

Question 29

Tradable pollution permits

Answer 29

Tradable pollution permits allow the voluntary transfer of the right to pollute from one firm to another

Question 30

Why pollution permits are better?

Answer 30

In some circumstances, selling pollution permits may be better than levying a Pigouvian tax where the government is not sure of an appropriate tax levy to achieve its goal

Question 31

Control of positional arms races

Answer 31

To reduce the instances of positional arms races, an incentive must exist to prevent the investment in attempts to gain some benefit which is ultimately mutually offsetting

Question 32

Objections to the Economic Analysis of Pollution

Answer 32

These people fail to understand that an economy has limited ability to eliminate pollution and such elimination would come at a high opportunity cost.
“People face trade-offs” and we must decide how much we would be willing to give up to have no pollution

Question 33

Government failure

Answer 33

Government failure is a situation where political power and incentives distort decision-making so that decisions are made which conflict with economic efficiency

Question 34

When might governments intervene?

Answer 34

in markets as a reaction to public pressure or moral panic spread by news organisations – not based on rational analysis and efficiency

Question 35

Public interest vs Public choice theory

Answer 35

Public interest: making decisions based on a principle where the maximum benefit is gained by the largest number of people at minimum cost.
Public choice theory is the analysis of governmental behaviour, and the behaviour of individuals who interact with government

Question 36

Three individuals who interact with the government

Answer 36

voters, law-markers or politicians and bureaucrats

Question 37

What does the public choice theory look at?

Answer 37

Public choice theory looks at cases where individual interest leads to decisions and the allocation of resources which may not be the most efficient allocation

Question 38

Rational ignorance

Answer 38

A voter tends not to not seek out information to make an informed choice in elections since they do not see their individual vote as making any difference (rational ignorance effect)
voters rely on bias information from their parents, TV coverage, and from leaflets supplied by political parties. As a result, the rational ignorance effect is reinforced

Question 39

Politicians will reflect the interests of the local communities they are seeking to serve

Answer 39

… claiming that they have public interest at heart
They want to be re-elected.
Some politicians can rely on the rational ignorance effect and voter inertia – voters are being aligned to a political party so no matter what the politician does (within reason of course) it is highly unlikely they will not get re-elected

Question 40

Bureaucrat

Answer 40

Civil servants providing advice have power

Question 41

Special Interest effect

Answer 41

may lead to minorities gaining significant benefits but the cost is borne by the population as a whole.

Question 42

Log rolling

Answer 42

a term used to describe vote trading in government

Question 43

Rent seeking

Answer 43

is where individuals or groups take actions to redirect resources to generate income (rents) for themselves or the group

Question 44

Inefficiency in the Tax System

Answer 44

Individuals and companies using of loopholes in the tax system to avoid paying tax.
Tax avoidance is legal.
Tax evasion is illegal and includes the informal economy

Question 45

Cronyism

Answer 45

Cronyism (returning favours) governments passing laws, instituting regulations, levying taxes and imposing subsidies which are a response to influence from or special interest groups in return for favours to increase the welfare of the individual politician or the government as a whole