LECTURE SEVEN EXTERNALITIES, PROPERTY RIGHT AND PUBLIC GOODS Flashcards
What is an externality?
An activity that has an indirect effect on other consumption or production activities that is not reflected directly in market prices
What are the two types of externalities based on their impact?
- Negative externalities - impose costs on another party
- Positive externalities - benefit another party
Give an example of a negative externality
A steel plant dumping waste in a river that harms fishermen downstream
Give an example of a positive externality
A homeowner repainting their house and planting a garden, benefiting all neighbors
What is Private Marginal Cost (PMC)?
The direct cost of producing an extra unit of a particular commodity
What is Marginal Damage (MD)?
Additional costs linked with production that are imposed on others but the producers don’t pay for
What is Social Marginal Cost (SMC)?
The sum of Private Marginal Cost (PMC) and Marginal Damage (MD)
How do negative production externalities affect market efficiency?
They cause overproduction and unnecessary social costs because firms don’t account for external costs
How do positive production externalities affect market efficiency?
They cause underproduction because firms don’t receive compensation for external benefits they create
What are property rights?
Legal rules that describe what people or firms may do with their property
Name four possible solutions to externalities
- Output tax
- Emissions standards
- Emissions fees
- Tradeable emissions permits
What is an emissions standard?
A legal limit set by the government on how much pollutant a firm can emit, with penalties for exceeding it
What is an emissions fee?
A charge levied on each unit of a firm’s emissions, encouraging firms to reduce emissions to minimize costs
What are tradeable emissions permits?
Marketable permits allocated among firms specifying maximum emission levels, which can be bought and sold
What are the two key characteristics of public goods?
- Non-rival
- Non-exclusive
What does non-rival mean?
The marginal cost of providing the good to an additional consumer is zero
What does non-exclusive mean?
People cannot be excluded from consuming the good
Give an example of a public good and explain why it qualifies
National defense - it’s both non-rival (protecting one more person costs nothing extra) and non-exclusive (can’t exclude anyone from protection)
What is a free rider?
A consumer or producer who doesn’t pay for a non-exclusive good expecting others will pay
How does the free rider problem affect public goods?
It makes it difficult for markets to provide public goods efficiently, often requiring government intervention
Why do externalities cause market inefficiency?
They inhibit market prices from conveying accurate information about how much to produce and buy
What is the Coase theorem?
Bargaining will lead to an efficient solution when property rights are clearly specified, transaction costs are zero, and there’s no strategic behavior
What makes bridge travel exclusive but non-rival during low traffic?
It’s exclusive because authorities can prevent usage, but non-rival because additional cars don’t affect others during low traffic
How should public goods be priced efficiently?
When the vertical sum of individual demands equals the marginal cost of production
What is an output tax and when is it used?
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.
