Externalities Flashcards
what is an 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
a type of market failure
market failure
A problem that causes the market
economy to deliver an outcome that does not maximize
efficienc
Negative production externality:
example
When a firm’s
production reduces the well-being of others who are not
compensated by the firm
Private marginal cost (PMC):
The direct cost to producers
of producing an additional unit of a good (e.g. use plastic
to make a toy)
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
how do negative production externalities affect cost
They drive wedge between private and social marginal cost
what do negative consumption externalities affect?
they drive wedge between private and social marginal benefit
Private marginal benefit (PMB):
The direct benefit to
consumers of consuming an additional unit of a good by
the consumer
Social marginal benefit (SMB):
The private marginal
benefit to consumers minus any costs associated with the
consumption of the good that are imposed on others
when is the market efficient? (thinking of marginal costs and benefits)
when SMC = SMB
When SMC = PMC and PMB = PMC
smc in negative production externality
SMC = PMC +MD
social marginal benefit in negative consumption externality
SMB = PMB - MD
what is marginal damage
what happens to others because of a unit of production or consumption
What do the four types of externalities lead to
Negative production externalities lead to over production
Positive production externalities lead to under production
Negative consumption externalities lead to over consumption
Positive consumption externalities lead to under consumption
internalizing externality
a private sector solution to negative externalities
When either private
negotiations or government action led the party to fully
reflect the external costs or benefits of that party’s actions
