Externalities Flashcards
What is an externality?
An indirect cost or benefit to a third party who is uninvolved in the market, that occurs as a result of another individual’s economic activity.
Give an example of a positive externality of production
- Caring externalities - people get utility out of knowing others are cared for
- Beekeeping - they improve agricultural yield
- Chocolate factory - others get utility out of the air smelling of chocolate
Give an example of a negative externality of production
Pollution
Give an example of a positive externality of consumption
Herd immunity from vaccines
Maintaining a garden
Give an example of a negative externality of consumption
Noise pollution
Passive smoking
Drunkenness
Congestion on the roads
What is the effect on a market if there are externalities in play?
Pareto efficiency cannot be met because private marginal costs & benefits are not equal to social marginal costs & benefits.
Draw a graph to show the impact on a market with a negative externality of production. Show the private costs, social costs and the deadweight welfare loss.
Draw a graph to show the impact on a market with a positive externality of production. Show the private costs, social costs and the deadweight welfare loss.
Draw a graph to show the impact on a market with a negative externality of consumption. Show the private costs, social costs and the deadweight welfare loss.
Draw a graph to show the impact on a market with a positive externality of production. Show the private costs, social costs and the deadweight welfare loss.
Demonstrate that the economically efficient level of a good that results in a negative externality is not zero.
The marginal social cost is the marginal private cost + marginal external cost
Based on this graph, even if the external cost of production should be 0 (in Q1), there would still be marginal private benefits to be gained from having some output.
What are potential policy options for dealing with negative externalities?
- Applying taxes to alter the private costs to be closer to the social costs
- Compensation to correct the market
What are potential policy options for dealing with positive externalities?
- Direct government provision of a good
- Subsidies to alter the private benefits to be closer to the private benefits
What is a deadweight welfare loss?
The overall loss in societal welfare that stems from the market equilibrium not being Pareto optimal.
What is the Coase theorem?
The theory that in the presence of externalities, parties can reach a mutually beneficial arrangement, that is economically efficient, if the property rights are well defined and the transaction costs are low.
What is a public good?
A good that is non-rival and non-excludable.
Describe the free-rider problem and explain why public goods must be publically funded.
The free-rider problem occurs when individuals cannot be excluded from a good that someone else has bought. Therefore, a rational person would not pay for the good, because they could be enjoying it for free, and eventually noone pays for the good, and production stops.
