L15: Externalities

Question 1

two classic and important market failures

Answer 1

externalities

public goods

Question 2

externalities

Answer 2

arise whenever the actions of one party directly make another party worse or better off, yet the first party neither bears the costs nor receives the benefits of doing so

distinct from effects on others through the price system

Question 3

types of externalities

Answer 3

positive vs negative

production externality: when a firm’s production reduces/increases well-being of others who are not compensated by the firm

consumption externality: when an individual’s consumption reduces/increases well-being of others who are not compensated by the individual

Question 4

private marginal cost (negative production externality)

Answer 4

direct cost to producers of producing an additional unit of a good

Question 5

social marginal cost (negative production externality)

Answer 5

private marginal cost to producers + any costs associated with the production of the good that are imposed on others (marginal damage)

Question 6

private marginal benefit (negative consumption externality)

Answer 6

direct benefit to consumers of purchasing an additional unit of a good

Question 7

social marginal benefit (negative consumption externality)

Answer 7

private marginal benefit to purchasers minus any costs associated with the good imposed on other consumpers

Question 8

negative production/consumption externality

Answer 8

drives a wedge between private and social marginal cost/benefit

Question 9

remedies for externalities

Answer 9

price policy: corrective taxation or subsidisation aimed at discouraging or encouraging activity

quantity policy: regulation to directly change activity level

Question 10

in an ideal world, taxation and regulation …

Answer 10

would be identical
- either adjust price to get socially efficient quantity or set quantity directly

in practice, complications that make taxes a more effective means of addressing externalities

Question 11

abatement costs

Answer 11

marginal cost of abatement has to equal marginal benefits of abatement

not talking about fairness but economic efficiency and DWL

Question 12

trading and tradeable permits

Answer 12

allows the market to incorporate differences in the cost of pollution reduction across firms

Question 13

corrective taxes vs. tradeable permits

Answer 13

both lead to efficient outcomes but two differences

initial allocation of permits - if government sets initial pollution rights to firms, equivalent to a tax with the same revenue
- but if the government gives them out for free, this is like imposing a corrective tax and giving firms the revenue

uncertainty in marginal costs
- two policies are no longer equivalent if we introduce uncertainty about costs of abatement
- taxes preferred if we know more about marginal damage but regulation preferred if we know more about optimal abatement level

Question 14

international externalities: global warming

Answer 14

requires international cooperation to solve

kyoto treaty 1997
- not ratified by the US, doesn’t cover developing countries
- reducing emissions of greenhouse gases to 5% below 1990 levels by 2010

paris agreement 2015
- not enough to keep global warming below 2C, the stated objective
- US pulled out in 2017 and rejoined in 2021

Question 15

US inflation reduction act 2022

Answer 15

subsidies for green technology and electric vehicles

but subsidies lose revenue, taxes raise revenue

subsidies also favour conservation measures over others
- advantages to some forms of abatement over others
- distorts behaviour