Module 6 Study Guide Flashcards
What are externalities? Give an example of a negative externality and a positive externality.
The effect of a market exchange on a third party who is outside or “external” to the exchange is called an externality. Because externalities that occur in market transactions affect other parties beyond those involved, they are sometimes called spillovers.
Externalities can be negative or positive. Examples of negative externalities are smoking or pollution because they negatively affect the health of those around you with secondhand smoke or asthma caused by pollution. Noise pollution is another less serious example. A paper mill’s negative externality would be the smell and bad fishing or affect on drinking water if there aren’t proper water regulations. Companies will probably produce more in these circumstances because they aren’t having to deal with the full cost of their production themselves. (I would definitely argue that the environmental degradation caused by corporations as well as the human rights violations should also be included in this.) (Since the marginal external costs are falling on people who aren’t the producer, the producer will choose to make more than they would if those costs fell on them.) Society is therefore going to want them to produce less to achieve the “socially efficient outcome” which limits the negative external impact on society.
What can you do if there is a negative externality?
Command & Control - Example: Calling the police for a noise complaint
Taxes - Example: Increase firm costs to decrease supply by having the government impose fines for pollution that equal the cost of cleaning up the river. (This raises their cost, decreases their supply, and essentially forces them to produce less.)
Better Defined Property Rights - Example: You change the property rights so that the town controls the river. Then the corporation wouldn’t have the right to pollute without getting permission from the people in the town. So defining the property and what can be done with certain things allows us to make better rules and enforce them to prevent them from doing things that impact the whole community in a negative way.
Marketable Permits- financial incentives to encourage a firm to pollute less. Basically if you pollute less and stay under this quota, then you get financial incentives for being able to do that.
(You need to do things that drag the supply curve to the left.) We need to figure out a way to increase the cost for producers so that their private supply curve reflects all of the costs borne by society. (Both the marginal cost of production and these marginal external costs) It often comes down to imposing taxes, fines, fees, or outlawing the things you don’t want. Discouraging engaging in these activities.
Positive externalities
The benefits of these things fall on people other than the producers or the consumers of the product. Example- producing vaccines. Like financial incentives.
2nd example: People getting degrees so that they make more money so that they can spend more in their community, state, country, etc. (spending money in your community and paying higher taxes, etc.) It helps you and society as a whole.
If there was no financial aid, the demand for college degrees would decrease dramatically. (when the government provides no incentives to go to college)
Social demand is going to be to the right of our private demand. Positive externalities impose additional benefits on society and shift the demand curve right. Our social demand is the regular old marginal benefit but it also includes marginal external benefit. Increase in tax revenue, disposable income spent in community, etc. So what we’d like to see is a GREATER amount of people producing vaccines, getting degrees, etc. Without extra incentives, we will see less of this than we actually want. The government’s function here is to intervene in the market in a positive way to drag the private demand curve to the right because it benefits all of us.
How to do this:
Patents - If someone patents a vaccine, they maximize their profits. (It would provide incentives but it wouldn’t help the common good.)
Tax Breaks
Subsidies
Vouchers
Getting more people to try to produce a vaccine through tax breaks, subsidies, and vouchers.
How is market efficiency impacted by a negative externality?
Negative externalities cause the market efficiency to be out of alignment because producers aren’t paying the full cost of what they’re producing while society pays those costs instead, so they produce more than they should be.
