Externalities & Market Failure Flashcards
What are externalities?
Externalities are spill-over effects on 3rd parties as a result of production/ consumption of a product.
What are private costs/ benefits?
Costs/ benefits on the producer/ consumer as a result of production/ consumption of a product.
Eg. revenue for firms, utility for consumers
What are external costs/ benefits?
Costs/ benefits on 3rd parties as a result of production/ consumption of a product.
Eg. pollution/ environment
What are social costs/ benefits?
Total costs/ benefits of production/ consumption to society.
Social = Private + External
Describe a negative externalities diagram.
MSC > MPC as there is an external cost. MSB = MPB. Socially efficient level is above free market production, therefore overproduction and deadweight loss.
What are the 4 ways to deal with negative externalities?
Environmental tax, Regulations/ bans, Extension of property rights, Tradeable permits.
How can environmental tax solve externalities and why may it not?
The firm is taxed the value of the externality, MPC shifts onto MSC. Firm reduces production.
However, its hard to value externality, and 3rd party isn’t compensated.
How can regulations/ bans solve externalities and why may it not?
Gvt limits output to Qs and firms prosecuted if they don’t comply.
However, no incentive for firms to comply (they may try to cheat the system), enforcement costs £.
How can extension of property rights solve externalities and why may it not?
Afflicted party owns asset and can deal with problem. (eg farmer owns river), compensation given to afflicted party. Externality internalises.
However, no incentive for firm to produce at Qs. Enforcement costs £.
How can tradeable permits solve externalities and why may it not?
Permits allow firms to create certain amount of pollution and total permits = Qs. Permits can be freely traded.
Also, good incentive to prod at Qs and selling permits can fund green investment.
But, £ of permits can fall making it cheap to pollute.
Describe a positive externalities diagram.
MSB > MPB as there is an external benefit. MSC = MPC. Socially efficient level is below free market production, therefore under consumption and deadweight loss.
Explain of the 4 ways of dealing with positive externalities.
Regulation - eg. minimum school leaving age. +ve externality, more skilled labour force
Increasing supply - Gvt can provide goods which are underprovided in the free market w/ external benefits, eg. building council houses.
Subsidies - to reduce the price and increase consumption. Shifts MSC = MPC to the right.
Provision of info - ensure there is no asymmetric info, eg. car dealers must reveal entire history of car so consumer knows what they are buying.
State and explain the 2 characteristics of a public good.
Non-excludable - once the product is consumed by someone, it doesn’t stop others from benefitting from their consumption.
Non-rivalry - when consumed, it does not reduce the total amount available for others to consume.
Explain the free rider problem.
When free riders benefit from a public good with little incentive to pay for it and compensate the producer, as they can benefit from the good without doing so.
How can the government respond to the free rider problem?
As the good cannot exist in a free market, the government may have to subsidise or produce the good themselves.
