externalities Flashcards
What is externality?
Externality: Externalities arise whenever the actions of
one party make another party worse or better off, yet the
first party neither bears the costs nor receives the
benefits of doing so.
an externality is present whenever some economic
agent’s welfare is “directly” (not through the market) affected by the action of
another agent in the economy
Negative production externality:
When a firm’s
production reduces the well-being of others who are
not compensated by the firm.
o Pollution from steel production, dumped in a river,
hurts fishermen
Negative consumption externality
Negative consumption externality: When an
individual’s consumption reduces the well-being of
others who are not compensated by the individual.
o Smoking at a restaurant affects the health and
enjoyment of others
What are PMC?
Private marginal cost (PMC): The direct cost to
producers of producing an additional unit of a good
Social marginal cost (SMC):
The private marginal cost to
producers plus any costs associated with the production
of the good that are imposed on others.
What is the effect in negative production externalities
Negative production externalities drive a wedge between
private and social marginal cost.
How do externalities affect efficiency?
*Efficiency requires that SMC = SMB.
*The market sets PMC = PMB.
*When PMC = SMC and PMB = SMB, the market is
efficient.
*Production or consumption externalities lead to
inefficiency.
Externalities undermine efficiency because one party
does not pay the costs or get all the (net) benefits of
its actions
What are the private sector solutions to negative externalities?
Internalizing the externality: When either private
negotiations or government action lead the price to
the party to fully reflect the external costs or benefits
of that party’s actions.
o The fishermen could pay the steel producer to
reduce production.
What’s part I of coase theorem?
when there are well-defined property rights
and costless bargaining, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially
optimal market quantity. This theorem states that externalities do not necessarily
create market failures because negotiations between the parties can lead the
offending producers (or consumers) to internalize the externality, or account
for the external effects in their production (or consumption)
What’s the role of government in dealing with externalities? And why?=
establishing property rights. the fundamental limitation to implementing private-sector solutions to
externalities is poorly established property rights. If the government can establish
and enforce those property rights, then the private market will do the rest.
What’s part ii of coase’s theorem?
t Part II: the efficient solution to
an externality does not depend on which party is assigned the property rights,
so long as someone is assigned those rights. Example of now the river belongs tot he steel plant, so the fisherman would pay the seellant 100$ for each unit of steel not produced, ans since they count ooportunity cost, this has the same effect as being forced to pay 100 for each unit produced.
What are the problems associated with Coase theorem?
- The assignment problem: Does the fisher pay the steel plant for not polluting? Or does the steel plant pay for polluting? Also consequences for investment in the long run.
- the holdout problem: property rights in question are held by more than one party: the shared property rights give each owner power over all others.(example:, suppose that the fishermen have property rights to the river, and the steel plant can’t produce unless all 100 fishermen say it can.Each fisherman walks up to the plant and collects his check for $1 per unit. As the last fisherman
is walking up, he realizes that he suddenly has been imbued with incredible power: the steel plant cannot produce without his permission because he is a
part owner of the river. So, why should he settle for only $1 per unit?)~
-The Free Rider Problem- when an investment has a personal cost
but a common benefit, individuals will underinvest.
-Transaction Costs and Negotiating Problems (the Coasian
approach ignores the fundamental problem that it is hard to negotiate when
there are large numbers of individuals on one or both sides of the negotiation)
Which are the three types of remedies that public policy makers use to resolve problems associated with negative externalities?
-Corrective taxation to discourage use (change the PMC and PMB without affecting SMC OR SMB —therefore they can be used to internalize externlity—————– taxes to correct externalities are PIGOUVIAN TAXES)
- subsidies to encourage use (
-regulation to directly change us- quantity regulation or market creation
How does corrective taxation work?
The government can still tax the
steel producer an amount MD (for the marginal damage of the pollution) for
each unit of steel produced. (making then PMC coincide with SMC and decreasing quantities).
Give an examply on how Government can use susbsidies for positive production externalities
other oil producers to take up a collection to pay the initial driller to
search for more oil reserves (thus giving them the chance to make more money
from any oil that is found). But, as we discussed, this may not be feasible. e. The
government can achieve the same outcome by making a payment, or a subsidy. The amount of this subsidy would
exactly equal the benefit to the other oil companies and would cause the initial
driller to search for more oil because his cost per barrel has been lowered
