Externalities Flashcards
What are externalities
Externalities are costs or benefits to third parties not directly involved in an economic activity
What are private costs
Private costs are the costs incurred by individuals directly involved in an economic activity
What are external costs
External costs are costs to third parties not directly involved in an economic activity
What are social costs
Social costs = Private costs + External costs
What are some examples of negative externalities
Pollution
Effects on non-smokers from passive smoking
Noise pollution
What are private benefits
Private benefits are the benefits gained by individuals directly involved in an economic activity
What are external benefits
External benefits are benefits to third parties not directly involved in an economic activity
What are some examples of positive externalities
Education
Healthcare
Vaccination
What are the advantages of taxation
Output of the good is reduced: When a tax is set on a product, its costs of production increase. This lead to a fall in supply, as producers are willing to supply less now that they make less profits. Consequently, less of the good is being produced and the negative externalities are reduced
Tax funds are raised: The money earned from a tax goes directly to the government. The government can use this additional funding to clean up the environment or even to compensate for the victims of pollution, thus reducing negative externalities
What are the disadvantages of taxation
The demand for a good may be price inelastic and the tax maybe ineffective at reducing pollution levels as people will keep buying it
The tax revenue raised might be used for other reasons instead for reducing negative externalities
What are the advantages of subsidies
Subsidies increase the demand for goods with external benefits: Subsidies help reduce the costs of production of a good, causing supply to increase. This increase in supply will lead to a fall in price and an increase in demand. Thus more goods with external benefits will be consumed
Subsidies decrease the demand of goods with external costs: Subsidies are given to firms that produce goods with positive externalities. The subsidies help to reduce the cost of production of a good, consequently decreasing its price and increasing its supply. Since more of a good with positive externalities is being consumed, consumption levels of its substitute good with negative externalities will be reduced.
What are the disadvantages of subsidies
There is an opportunity cost to government subsidies. Money given to firms will lead to higher taxes or cuts in government spending somewhere else, as the government will need to make up for the money they gave
When a firm is given a subsidy, they might rely too much on it and they consequently won’t have any motivation to produce more. Thus, their productivity might fall
What are the advantages of regulation
Regulation can limit the extent of the activity: Regulations are laws that prevent the production of a good, as those that don’t obey them are fined or even imprisoned. Since producers want to avoid the punishments, they reduce supply for goods with negative externalities
Development of new technologies: When producers are stopped from doing a particular activity, they have to find a new way to produce if they want to keep their business alive. This encourages them to produce new technologies that pollute less
What are the disadvantages of regulation
Corruption
The cost of enforcing and monitoring the law
What are tradable pollution permits
Tradable pollution permits are permits that allow firms to pollute up to a certain level.
