L 25 - Externalities

Question 1

What is Market Failure?

Answer 1

A failure to efficiently allocate resources in the market

Question 2

What are the characteristics of Market Failure?

Answer 2

1) Externalities can be positive (benefits on a 3rd party) or negative (costs on a 3rd party)

A market produces:

i) Too much if there’s a negative externality
ii) Too little if there is a positive externality

2) Externalities can be created in the production or in consumption
3) Banning all products with negative externalities is not socially desirable (the right amount finds the best trade off between its benefits and costs)

Question 3

How should a social planner correct the effects of an externality?

Answer 3

1) Tax activities that are produced too much by markets
2) Subsidise activities that are produced too little by markets

This way, the social planner can internalise the efficiency

Question 4

What does Pigovian Tax do?

Answer 4

Corrects the effects of a negative externality.

Named after Arthur Pigou

Question 5

Why is a Pigovian Tax better than regulation?

Answer 5

1. The tax will reduce pollution
2. The tax reduces pollution more effectively
3. Tax is better for the government
4. The tax raises money for the government

Question 6

All the graphs on notes

Answer 6

….