Lecture 1: Introduction & fundamentals

Question 1

What is an economic efficient market?

Answer 1

An allocation of resources that maximise net social benefits; perfectly competitive market in the absence of externalities.

Question 2

What does a social marginal cost curve show?

Answer 2

The cost of providing one more unit of a good or service considering both private production costs and externalities.

Question 3

What is the definition of a pigovian tax?

Answer 3

A per-unit tax set equal to the external damage caused by an activity.

Question 4

Why is an upstream tax applied?

Answer 4

Because it limits administrative complexity of tax collection & avoids the need for estimating the appropriate tax for a multitude of products.

Question 5

What are issues related to our externality analysis?

Answer 5

1. Putting taxes on all products is hard.
2. Tax distribution between consumers and producers.
3. Tax can fall disproportionately on certain income groups.

Question 6

In case of a positive externality, what is the most common policy to correct the market inefficiency?

Answer 6

A subsidy.

Question 7

What does a welfare analysis do?

Answer 7

It shows why it is socially preferable to internalise externalities. It is an economic tool that analyses the total costs and benefits of alternative policies to different groups, such as producers and consumers.

Question 8

What is the net social benefit?

Answer 8

The sum of consumer and producer surplus minus externality damages.

Question 9

What is the coase theorem?

Answer 9

The proposition that if property rights are well defined and there are no transaction costs, an efficient allocation of resources will result even if externalises exist.

Question 10

What is free market environmentalism?

Answer 10

The view that a more complete system of property rights and expanded use of market mechanisms is the best approach to solving issues of resource use and pollution control.

Question 11

What is criticism to the case theorem?

Answer 11

1. The free rider effect (people avoid paying for a resource, although they gain benefits of them)
2. Holdout effect (one single entity hinders the agreement by setting disproportional demands)
3. No environmental justice

Question 12

What is the law of diminishing returns?

Answer 12

After a certain point, the the addition of one more unit of input will not proportionally increase output and may even lead to a decline in the marginal returns.

Question 13

What is the definition of an externality?

Answer 13

An impact that affects the well-being of those outside of a market transaction.

Question 14

What does an equilibrium show?

Answer 14

An economic efficient situation where the total benefits of the market are maximised.

Question 15

What does the equilibrium price show?

Answer 15

The market price where the quantity supplied equals the quantity demanded.

Question 16

What is the ‘correct tax amount?

Answer 16

If we set the Pigovian tax exactly equal to the externality damage, then the marginal cost of production would equal the social marginal cost curve

Question 17

How does the market react to a pigovian tax?

Answer 17

The market will adjust to the Pigovian tax by shifting to a new equilibrium, with a higher price of P* and a
lower quantity of Q*

Question 18

Why does the quantity goes down when a Pigovian tax is applied?

Answer 18

Even though the tax was levied on producers, a portion of the tax is passed on to consumers in the form of a price increase for automobiles (from Pm to P). This causes consumers to cut back their purchases from Qm to Q.

Question 19

What is an example of an elastic demand curve?

Answer 19

Luxury goods like smartphones and designer clothes, if the price goes up, people switch easy to a less expensive brand

Question 20

What is an example of an inelastic demand curve?

Answer 20

Necessary goods, brand-loyal people, not easily replaceable.

Question 21

What is an example of an elastic supply curve?

Answer 21

Hamburgers, if the price rises, factories can quickly respond by producing more so that the supply increases.

Question 22

What is an example of an inelastic supply curve?

Answer 22

Vintage cars, supply doesn’t change much with price fluctuations, because they are unique and can’t be produced more.

Question 24

When does an unregulated market also fail to maximise social welfare in presence of a positive externality?

Answer 24

Because they do not account for the full benefits associated with certain goods or services. Fe: when a subsidy is applied, more people would buy a solar panel and the market would be better off.

Question 25

What is equivalent to the net social welfare?

Answer 25

The sum of consumer + producer surplus minus the external damages + the benefit of tax revenues.

Question 26

Why do we need a maximum (or WTA) level of pollution? (willing to accept)

Answer 26

We need to set a maximum level of acceptable pollution based on health and ecological considerations,
rather than economic analysis (otherwise ever-rising levels of pollution will, in some sense, be acceptable) so that net social benefits are maximised.

Question 27

On which principles is free market environmentalism based?

Answer 27

On the principle that environmental problems can be more efficiently and effectively solved through voluntary exchanges, property rights, and the principles of a free market, rather than relying solely on government regulations and centralised control.

Question 28

What is the principle behind a tax?

Answer 28

In general, the use of such a tax will raise the price and reduce the quantity produced of the good, thereby also reducing pollution. In so doing, it shifts the market equilibrium to a socially more desirable result. In theory, a tax that exactly reflects external costs could achieve a social optimum, but it is often difficult to establish a proper valuation for negative externalities.

Question 29

The term ‘right to pollute’ refers to the concept of a cap-and trade system’, what does this mean?

Answer 29

A system where the government establishes an overall limit or cap on the total amount of a specific pollutant that can be emitted by a group of entities or within a particular jurisdiction. These entities, such as businesses or industries, are then allocated permits that grant them the right to emit a certain quantity of the specified pollutant.

Question 30

When is the right to pollute system not effective?

Answer 30

When a large number of people are affected, where env. damages are not easy to define in monetary terms. Furthermore, it raises questions of equity because the poor usually carry a heavier burden of pollution.

Question 31

Why is the environment a public good?

Answer 31

Because it is available to all (nonexcludable) and the use by one person does not reduce their availability to others (nonrival).

Question 32

What is the effect of reaching an optimal level of pollution in the coase theorem?

Answer 32

At this level, the extra benefit
to the company from production balances the extra cost imposed on the community through pollution

Question 33

How long will the negotiation would continue in the coase theorem

Answer 33

As long as the marginal benefits to the company exceed the marginal damages to the community. However, the space for successful negotiation gradually declines as we move rightward on the graph

Question 34

How does an increase/decrease in the price of gasoline change the demand curve?

Answer 34

An increase in the price for gasoline typically leads to a decrease in the quantity demanded, resulting in a movement along the demand curve rather than a shift. Similarly, a decrease in the price of gasoline would generally lead to an increase in quantity demanded but does not shift the entire demand curve

Question 35

What is utility?

Answer 35

How much benefit/value/satisfaction you get of getting a good or service

Question 36

What is the theory of the invisible hand?

Answer 36

The basic idea is that when individuals act in their own self-interest in a competitive market, they unintentionally end up benefiting others.

Producers: In trying to make a profit, businesses provide goods and services that people want. This helps satisfy the needs and wants of consumers.

Consumers: By choosing products and services that best meet their needs, consumers indirectly guide businesses to produce what the market demands. This encourages efficiency and innovation.

Competition: The competition among businesses helps keep prices reasonable and encourages them to improve the quality of their products or services.

Question 37

What is positivistic economics?

Answer 37

Describe what was and what is (E.g. What are the costs of reducing emissions? & How much does demand ↓if the price ↑
● Past, current and future trends in micro and macro economics)

Question 38

What is normative economics?

Answer 38

Deals with what ought to be from a broad welfare perspective, not only from an economic perspective (E.g. How much pollution should be allowed? & are market outcomes desirable?).

Question 39

How does a demand curve respond to elasticity of demand?

Answer 39

The higher the price elasticity of demand, the flatter the demand curve.

Question 40

Why is the supply curve upward sloping? (law of supply)

Answer 40

Because in general, as the price of a good goes up, producers are willing to supply more of that good to the market. Due to:
- Higher price means higher profit
- Law of diminishing marginal returns

Question 41

What is the law of diminishing marginal returns?

Answer 41

It is based on the idea that there are limits to the benefits of increasing the amount of a good, because the satisfaction is getting less with every unit you buy/sell