Externalities Flashcards
What are externalities?
Costs or benefits that affect third parties not involved in the economic transaction.
What is a positive externality in production?
Bees pollinating orchards.
Example of a positive externality in production.
What is a positive externality in consumption?
Vaccination or telecom network subscribers.
Example of a positive externality in consumption.
What is a negative externality in production?
CO2 emissions, noise pollution from factories.
Example of a negative externality in production.
What is a negative externality in consumption?
Smoking or noise from neighbors.
Example of a negative externality in consumption.
What is Pareto Efficiency?
Achieved when no one can be made better off without making someone else worse off.
What is the Marginal Rate of Transformation (MRT)?
The rate at which production of one good can be transformed into another.
How does MRT change with externalities?
MRT changes because the externality affects output, requiring more inputs to maintain the same output.
What is the First Welfare Theorem?
In absence of externalities, competitive equilibrium is Pareto efficient.
What happens in competitive equilibrium with externalities?
Firms do not internalize externalities, leading to inefficiencies.
What are quotas?
Limits on the production of a good that causes a negative externality.
What are Pigouvian Taxes?
Taxes designed to correct market inefficiencies by internalizing externalities.
What is the Coase Theorem?
If transaction costs are low, firms can negotiate to internalize externalities through private bargaining.
What is cap and trade?
A system where firms can buy and sell pollution permits to reduce overall pollution efficiently.
What challenges exist with government interventions?
Quotas and taxes require detailed knowledge of production technologies and external costs.
