Externalities Flashcards
Define externalities in economics
A cost or benefit arising from an economic activity that affects third parties which are not directly involved in the activity
What is Market failure
Where the price mechanism fails to efficiently allocate scarce resources
What is the Price mechanism
The price mechanism is what determines where resources are allocated depending on the interaction between firms and consumers
What are the 3 Components of the price mechanism
Signaling, Insentive,
Rationing
What is Signaling?
Sends a message to producers or consumers telling them that there is a change in the supply of a good
What is an Insentive
An insentive is what makes firms want to produce more as it is more profitable
What is rationing
A change in price can be only suitable to a limited amount of people. Products are rationed between those who most want it
Rationing only happens when…
There is Excess demand
When does Market failure take place
When the price mechanism fails to efficiently allocate resources
What are the 4 reasons for market failure
Negative Production
Negative Consumption
Positive production
Positive consumption
What is a Private cost
Cost to firms producing the good
what is a private benefit
Benefit to consumers of consuming the good
What is a Negative production Externality
A cost thats created by producing a good which affects the rest of society
What is a Negative Consumption Externality
A cost thats created for consuming a good which affects the rest of society
What is a Positive production externality
A benefit created from producing a good or service which benefits the rest of society
what is a positive consumption externality
A benefit produced from consuming s good which benefits the rest of society
Where will the Welfare loss triangle point to on a Externality Diagram
Towards the social optimum
what is the equation for Marginal Social Cost (MSC)
Private cost + Externalities
What is the equation for Marginal Social Benefit (MSB)
Private benefit + Externality
