Externalities Flashcards
What is a externality?
- Welfare of one agent is directly affected by the actions a second agent
- There is no market to evaluate this effect and reward or penalise against the second agent accordingly
Why do competitive firms create excessive amounts of negative externalities?
Because they do not have to pay for the harm done
Why do producers and individuals only produce small positive externalities?
Because they are not compensated for it
What is the primary result of externalities?
Non-optimal production and consumption
What does the marginal external cost show?
The marginal external cost (MEC) measures the damage to the enviroment caused by the production of an additional unit of good
What does the marginal private cost show?
The private cost of producing an additional units of good
What does the marginal social cost show and how can it be found?
The sum of the private marginal cost curve and marginal external cost of pollution MSC= MPC + MEC
Where can the optimal point be found when assessing the demand curve with respect to marginal social costs and marginal private costs?
The optimal point is where the firm treats the social cost as its own cost function this minimises the dead weight loss
Why is a social optimum not achieved at a competitive equilibrium?
Because the prices too low and demand is too high, relative social optimum
What is the reason for the social optimum not being equal to the marginal private cost?
Cost of pollution is ignored in consumption and production. We say, producers, do not internalise the externality on consumers.
What is the marginal external benefit?
The benefit to the enviroment (other people) from the consumption of each additional unit of good
What is the marginal social benefit?
The sum of the marginal private benefit and the marginal external benefit
What is the marginal private benefit the same as?
The inverse demand curve
Under the positive consumption externalities model, where is the competitive equilibrium?
Where MC (q) = MPB (q)
Under the positive consumption externalities model, where is the socially optimal outcome?
Where MC(q^s) = MSB (q^s)
Does the firm produce too much or too little at the competitive equilibrium under positive consumption externalities?
In competitive equilbrium, the price is too high and demand too low relative to the socially optimal point
What is a common remedy to externality problems?
A common solution is a Pigou tax or a subsidy
How would a subsidy work under a positive consumption externalities model?
To reach the social optimum open, expand, supposedly government wants to pay consumers a subsidy s = p^s - p^d, where p^d is the MPB at qs
What is the location of the contract curve dependent on?
The location of the contract curve depends on the trading mechanism and the legal system
Why do problems often arise in the trading model?
Because property rights are sometimes poorly defined because it means that they will never negotiate
What is the Coase theorem?
With property rights that are well defined and low transaction costs, parties involved can resolve externalities themselves through private negotiations
How can we solve externality problems?
- Subsidies/ taxes
- Pollution permits
- Emission Standards
- Mergers
- Property right allocation and bargaining
STEMPP
What is a Pigouvian tax equal to?
The external cost associated with the economic activity
What is a property right?
An exclusive privilege to use an asset
