Market Failure: Externalities

Question 1

Externalities/Spill Overs

Answer 1

Economic transactions generate costs and benefits
Often, these costs and benefits fall on third parties.
These costs and benefits are not considered by those undertaking the transaction.
Third parties are not compensated for the cost or benefit falling upon them.
Also know as spillovers

Question 2

Negative Externalities

Answer 2

Negative externalities – lead to oversupply of a good/service

Question 3

Positive Externalities

Answer 3

Positive externalities – lead to undersupply of a good/service

Question 4

Responses to Externalities: Socialisation and Internalisation Processes

Answer 4

Socialisation and internalisation processes

Internalise the divergence between MPC and MSC (or MPB and MSB)
Information, advertising and propaganda campaigns
Guilt – “bloody idiot”, “pig” etc.

Question 5

Responses to Externalities: Mergers

Answer 5

(e.g. vertical and horizontal integration and form conglomerates)

Question 6

Responses to Externalities: Goverenment Intervention

Answer 6

Government intervention
Regulation
Property Rights
the Coase Theorem
Fines/Rewards 
Can use taxes/fines to increase MPC

Question 7

The Coase Theorem

Answer 7

The Coase theorem is a proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

Question 8

What is a pigovian tax

Answer 8

Sets the price of pollution which, together with the demand curve determines the quantity of pollution

Question 9

What is a pollution permit

Answer 9

Pollution permits set the quantity of pollution which, together with the demand curve determines the price of pollution