Externalities Flashcards
Externality
the uncompensated impact of one person’s actions on the well-being of a bystander
What happens to the market equilibrium when there are externalities? (Is it efficient or not efficient?)
the market equilibrium is not efficient (it fails to maximize the total benefit to society as a whole)
buyers and sellers don’t take into account the external effects of their actions
What does it mean when a market is efficient?
the market allocates resources in a way that maximizes the total value to the consumers who buy and use the good minus the total cost to the producers
What happens with a negative externality?
the cost of producing the good to society as a whole is bigger than the cost created by the producers of the good
the social cost equals the private costs of the producers plus the cost to the bystanders harmed
Where does the social cost lie on the graph for a negative externality?
the social-cost curve is above the supply curve
takes into account the external costs imposed on society by the production of the good
Where should the quantity of the good be produced? (where is it on a graph?)
the point where demand (private value) intersects the social cost (private cost and external cost)
What does “internalizing the externality” mean?
altering incentives so that people take into account the external effects of their actions
Where does the social value curve lie when there is a positive externality?
the social value curve lies above the demand curve
What does a positive externality lead markets to do?
leads markets to produce a smaller quantity than is socially desirable
Command-and-control policies
regulates behavior directly
can either require or forbid certain behaviors
Market-based policies
provides incentives so that private decision makers will choose to solve the problem on their own
Corrective taxes
a tax designed to to induce private decision makers to take into account the socials costs that arise from a negative externality
places a price on the right to do the bad thing
What two things do corrective taxes do?
raises revenue for the government
enhance economic efficiency
when is government action needed?
Government action is needed when private solutions fail to arise
An optimal tax on pollution would result in what?
Producers will internalize the cost of pollution
