Lecture 10- Externalities and public goods

Question 1

What is an externality and when do they occur?

Answer 1

They occur when a persons well being of a firms production capability is directly affected by the actions of other consumers or firms rather than indirectly through prices.

Question 2

What is a negative externality?

Answer 2

An activity that imposes external costs on others.

Question 3

What is an example of a negative externality?

Answer 3

A firm whose production process lets off fumes that harm its neighbours is creating an externality, which is not traded in the market.

Question 4

What is a positive externality?

Answer 4

An activity that creates external benefits for others

Question 5

What is the rule between marginal social benefit and marginal social cost?

Answer 5

It is efficient to increase the level of activity as long as MSB marginal social benefit is greater than marginal social cost MSC.

Question 6

What is a private cost?

Answer 6

The cost of production only, not including externalities

Question 7

What is a social cost?

Answer 7

The private cost plus the cost from externalities (i.e. pollution)

Therefore, the presence of externalities may cause a market to operate inefficiently.

Question 8

Why does a deadweight loss results from externalities?

Answer 8

Because the competitive market equates price with private marginal cost instead of with social marginal cost.

A competitive market produces excessive externalities.

Question 9

Explain the Coase Theorem

Answer 9

It suggests that under certain conditions, private parties can negotiate and resolve externalities on their own without government intervention, leading to an efficient allocation of resources.

Question 10

What are the key components of the Coase theorem?

Answer 10

Well-defined property rights: Property rights must be clearly specified. It must be clear who owns the resource or has the right to take actions.

Low transaction costs: Costs of bargaining, enforcement and information, if these are too high then private negotiations might fail.

Efficient outcomes

However, the theorem underscores the importance of well-defined property rights to address externalities effectively.

Question 11

What is a pure public good?

Answer 11

A good that has a high degree of non-diminishability and non-excludability

Question 12

What is a pure private good?

Answer 12

A good that has a high degree of diminishability and excludability.

Question 13

What is the meaning of rivalry in consumption?

Answer 13

Means that only one person can consume a good.

Question 14

What is the meaning of exclusion in consumption?

Answer 14

Others can be prevented from consuming a good.

Question 15

What are examples of pure public goods?

Answer 15

National defence

Street lighting

Clean air

Public broadcasting (BBC)

Question 16

What are examples of pure private goods?

Answer 16

Food

Clothing

Electronics

Vehicles

Question 17

What is a collective good?

Answer 17

A good that is excludable but has a high degree of non-diminishability e.g. community services

Question 18

What is an in-pure pubic good?

Answer 18

A good that has some non-diminishability and non-excludability e.g. education.

Question 19

What graph or measure should we use to analyse the provision of public goods?

Answer 19

Aggregate willingness to pay curve for a public good.

Question 20

How can public goods be paid for without mandatory taxes?

Answer 20

Funding by donation: The only challenge is free rising, where many individuals benefit without donating, which can lead to underfunding of too many people choose to not contribute.

Sale of By-products: E.g. radio stations may provide free programming funded by advertising revenue. However, the challenge is that they may not always produce enough revenue.

Private contracts: Group of beneficiaries agreeing in advance to share the cost of provision, often enforced by legal agreements.
e.g. businesses may collectively fund security or infrastructure improvements in industrial parks.
The only challenge is that is requires coordination and legal enforcement to prevent individuals from opting out while still benefiting.