LECTURE SEVEN EXTERNALITIES, PROPERTY RIGHT AND PUBLIC GOODS

Question 1

What is an externality?

Answer 1

An activity that has an indirect effect on other consumption or production activities that is not reflected directly in market prices

Question 2

What are the two types of externalities based on their impact?

Answer 2

1. Negative externalities - impose costs on another party
2. Positive externalities - benefit another party

Question 3

Give an example of a negative externality

Answer 3

A steel plant dumping waste in a river that harms fishermen downstream

Question 4

Give an example of a positive externality

Answer 4

A homeowner repainting their house and planting a garden, benefiting all neighbors

Question 5

What is Private Marginal Cost (PMC)?

Answer 5

The direct cost of producing an extra unit of a particular commodity

Question 6

What is Marginal Damage (MD)?

Answer 6

Additional costs linked with production that are imposed on others but the producers don’t pay for

Question 7

What is Social Marginal Cost (SMC)?

Answer 7

The sum of Private Marginal Cost (PMC) and Marginal Damage (MD)

Question 8

How do negative production externalities affect market efficiency?

Answer 8

They cause overproduction and unnecessary social costs because firms don’t account for external costs

Question 9

How do positive production externalities affect market efficiency?

Answer 9

They cause underproduction because firms don’t receive compensation for external benefits they create

Question 10

What are property rights?

Answer 10

Legal rules that describe what people or firms may do with their property

Question 11

Name four possible solutions to externalities

Answer 11

1. Output tax
2. Emissions standards
3. Emissions fees
4. Tradeable emissions permits

Question 12

What is an emissions standard?

Answer 12

A legal limit set by the government on how much pollutant a firm can emit, with penalties for exceeding it

Question 13

What is an emissions fee?

Answer 13

A charge levied on each unit of a firm’s emissions, encouraging firms to reduce emissions to minimize costs

Question 14

What are tradeable emissions permits?

Answer 14

Marketable permits allocated among firms specifying maximum emission levels, which can be bought and sold

Question 15

What are the two key characteristics of public goods?

Answer 15

1. Non-rival
2. Non-exclusive

Question 16

What does non-rival mean?

Answer 16

The marginal cost of providing the good to an additional consumer is zero

Question 17

What does non-exclusive mean?

Answer 17

People cannot be excluded from consuming the good

Question 18

Give an example of a public good and explain why it qualifies

Answer 18

National defense - it’s both non-rival (protecting one more person costs nothing extra) and non-exclusive (can’t exclude anyone from protection)

Question 19

What is a free rider?

Answer 19

A consumer or producer who doesn’t pay for a non-exclusive good expecting others will pay

Question 20

How does the free rider problem affect public goods?

Answer 20

It makes it difficult for markets to provide public goods efficiently, often requiring government intervention

Question 21

Why do externalities cause market inefficiency?

Answer 21

They inhibit market prices from conveying accurate information about how much to produce and buy

Question 22

What is the Coase theorem?

Answer 22

Bargaining will lead to an efficient solution when property rights are clearly specified, transaction costs are zero, and there’s no strategic behavior

Question 23

What makes bridge travel exclusive but non-rival during low traffic?

Answer 23

It’s exclusive because authorities can prevent usage, but non-rival because additional cars don’t affect others during low traffic

Question 24

How should public goods be priced efficiently?

Answer 24

When the vertical sum of individual demands equals the marginal cost of production

Question 25

What is an output tax and when is it used?

Answer 25

A tax imposed to reduce production when a firm generates externalities. It’s most effective when the firm has a fixed-proportion production technology and the externality can only be reduced by producing less.