EMI3- Externalities

Question 1

When does the problems of externalities arise?

Answer 1

The problem of externalities arises where there exists an untraded or unpriced good or service such that an excess demand or supply arises – that is the market fails to clear – and the outcome is not Pareto Efficient.

Question 2

What necessary assumption which is an essential condition for a Pareto efficient outcome does the existence of externalities violate?

Answer 2

The existence of externalities violates the assumption of well-defined property rights

Question 3

List 4 possible solutions for externalities?

Answer 3

• Permits,
• Allocation of property rights,
• (Pigouvian) taxes
• Standards.

Question 4

What are the 3 main types of externality?

Answer 4

• Network Externality
• Consumer Externality
• Production Externality

Question 5

• What are Network Externalities characterised by?
• What does this mean?
• Give 2 examples
• How do we write out the marginal benefit to the consumer of using the good?

Answer 5

• The Bandwagon Effect
• The marginal value of the good to a consumer increases with increases in the number of others that use the good
• Examples include fax machines and social media networks. Examples include fax machines and social media networks.
• Marginal Benefit = f(n)

Question 6

What is the critical mass?

Answer 6

The point where the Marginal Benefit is greater than the cost of obtaining the good. Eg only getting a phone when 20 of your friends also have one.

Question 7

What is the shape of the graph in (n,MB) space?

Answer 7

Concave (ie diminishing marginal benefit)

Question 8

What kind of externality is smoking?

Answer 8

Smoking is a consumption externality

Question 9

Suppose there are no property rights in the smoking scenario, what could then happen?

Answer 9

The non-smoker could try and bribe the smoker to reduce their smoking, but the smoker could just accept the money and continue smoking as normal. Or the smoker could reduce their consumption and then the non-smoker could refuse to pay.

Question 10

Therefore, with no property rights, what is the realistic outcome?

Answer 10

The smoker will smoke as much as they like.

Question 11

What do property rights give us?

Answer 11

An enforceable market

Question 12

What happens if the smoker gets given property rights?

Answer 12

The market will start off with maximum smoking, but the non-smoker will be able to pay them to reduce their smoking until both individuals indifference curves are tangential to each other, at the Pareto efficient outcome.

Question 13

Does resolving market failure mean eliminating smoking?

Answer 13

No

Question 14

What happens if the non-smoker gets given property rights?

Answer 14

The market will start off with minimum smoking, but the smoker will be able to pay them to increase their smoking until both individuals indifference curves are tangential to each other, at the Pareto efficient outcome.

Question 15

What is the Coase Theorem?

Answer 15

• If through the allocation of property rights a market can be created for the externality then an efficient outcome will result regardless of who is given the property rights.

Question 16

• How do many of the problems with Coase Theorem come about?

* Explain

Answer 16

• Transaction costs
• Transactions costs of allocating and enforcing property rights are going to be higher as the number of agents involved in the market increases and as the subject of the property rights becomes harder to observe/measure.

Question 17

What kind of externality is pollution?

Answer 17

Pollution is a production externality

Question 18

How do we resolve the Pollution externality?

Answer 18

We introduce a per unit tax t, (otherwise known as a Pigouvian tax) to make MPB=MPC=MSC

Question 19

• Who introduced the idea of Tragedy of the Commons?
• What does the idea refer to?
• Give a real world example

Answer 19

• Hardin 1968
• If multiple agents have access rights to a common resource, over-dissipation of the resource will happen.
• Overfishing

Question 20

• Why does the tragedy of the commons occur?

* What does this say about the market

Answer 20

• Because individuals optimise their behaviour for their own personal gain, but this has negative externalities
• The market fails to efficiently allocate the resource. Effectively the price of using the commons is too low and the quantity too high.

Question 21

What is a possible solution to the tragedy of the commons?

Answer 21

Establish a single agent who controls the commons, a monopoly, and assign them alone the access rights. The single owner of the access rights then maximises their rent by restricting the usage by other agents (setting the monopoly price for access) and maximising the value of the resource.

Question 22

• Who introduced the idea of Tragedy of the Anticommons?
• What does the idea refer to?
• Give a real world example

Answer 22

• Heller 1998
• Multiple agents having exclusion rights
• A nightclub needing 3 tickets to enter, if each seller maximises their profit, the total price will be too high for people to go,

Question 23

• Why does the tragedy of the anticommons occur?

* What does this say about the market

Answer 23

• Because individuals optimise their behaviour for their own personal gain, but this has negative externalities
• The market fails to efficiently allocate the resource. Effectively the price of using the commons is too high and the quantity too low.

Question 24

What is a possible solution to the tragedy of the anticommons?

Answer 24

One solution to the anti-commons problem is to establish a single agent who controls the commons, a monopoly, and assign them alone the exclusion rights. The single owner of the exclusion rights then maximises their rent setting the monopoly price for and maximising the value of the resource.

Question 25

What other model is a parallel to the tragedy of the anticommons?

Answer 25

Complimentary monopoly is mathematically equivalent, as with n components joined together in a composite good, but if we have a monopolist supplier of each component and they price independently, price goes above the monopoly level and quantity goes below

Question 26

What did Buchanan and Yoon (2000) note?

Answer 26

• The reduction in value is symmetric in n under exclusion/access
• This makes commons and anticommons formally equivalent
• However, this is merely a direct result of the formal equivalence of Cournot’s two models as noted by Sonnenschein (1968).

Question 27

What is the Cournot oligopoly akin to?

Answer 27

The Commons

Question 28

What is the Cournot complimentary monopoly akin to?

Answer 28

The anticommons

Question 29

What is revenue in the commons and what does this mean?

Answer 29

• R=n/(n+1)^2
• ∂R/∂n=-((n-1))/(n+1)^3 ≤ 0
• This is decreasing in the number of agents with access to the commons, we can say that the greater the number of agents the greater the damage to the commons via the externality

Question 30

What are price and quantity in the commons?

Answer 30

• Q=n/(n+1),

* P=1/(n+1)

Question 31

What are price and quantity in the anticommons?

Answer 31

• P=n/(n+1),

* Q=1/(n+1)

Question 32

What is revenue in the anticommons and what does this mean?

Answer 32

• R=n/(n+1)^2
• ∂R/∂n=-((n-1))/(n+1)^3 ≤ 0
This is decreasing in the number of agents with access to the commons, we can say that the greater the number of agents the greater the damage to the resource via the externality