Part 4 [The Economics of the Public Sector] - 10. externalities - 11. public goods and common resources - 12. the design of the tax system Flashcards
What is an externality?
The uncompensated impact of one person’s actions on the well-being of a bystander.
What is the difference between a negative and positive externalities?
Negative externalities have adverse effects.
Positive externalities have beneficial effects.
Why are market equilibriums not efficient when there are externalities?
Because buyers and sellers neglect the external effects of their actions when deciding how much to demand or supply.
How does the cost curve appear in the presence of a negative externality?
As a social cost curve above of, and parallel to the private cost curve.
Why would a social planner chose the level of production at which the demand curve crosses the social-cost curve?
This intersection determines the optimal amount from the standpoint of society as a whole.
Why is Qmarket larger than the Qoptimum in the presence of negative externalities?
In the market equilibrium, the marginal consumer values the good less than the social cost of producing it.
How is producer surplus measured in the presence of a negative externality?
The amount received by sellers minus the social costs of production (which include the private costs and social costs)
How do we graphically represent the loss of total surplus due to a negative externality?
As the area of the triangle formed by the social cost curve and the demand curve between Qoptimum and Qmarket.
What does the height of the social-cost curve in the presence of a negative production externality incorporate?
The seller’s private costs of production plus the social-cost imposed on others due to the negative externality.
How can a social planner achieve the socially optimal level of production and eliminate the deadweight loss associated with the externality?
One way would be to tax producers for each unit of quantity sold. The tax would shift the supply curve up by the size of the tax.
Why is a tax used to correct negative externalities?
to force producers to internalize the externality.
What does it mean to internalize the externality?
To alter incentives so that people take account of the external effects of their actions.
What 3 ways does education yield positive externalities?
A more educated population leads to;
- a more informed voters, which means better government for everyone
- lower crime rates
- the development and dissemination of technological advances, leading to higher productivity and wages for everyone.
How does the social-value curve appear in the presence of a positive externality?
Because the social value is greater than the private value, the social-value curve lies above and parallel to the demand curve.
How does a social planner move the market equilibrium closer to the social optimum when there are positive externalities?
With subsidies.
Summarize the analysis of externalities.
Negative externalities lead markets to produce a larger quantity than is socially desirable. Positive externalities lead markets to produce a smaller quantity than is socially desirable. To remedy the problem, the government can internalize the externality by taxing goods that have negative externalities and subsidizing goods that have positive externalities.
What is industrial policy?
Government intervention in the economy that aims to promote technology-enhancing industries.
Apart from industry policy, what is another way to encourage technological advances?
With patent protection.
What two types of policy can government use to respond to externaliies?
- Command-and-control policies
- Market-based policies
How does the government remedy externalities with command-and-control policies?
Through regulation.
What do government need to know in order to properly regulate a market?
The details about specific industries and about the alternative technologies that those industries adopt. This information is often difficult for government regulators to obtain.
How does the government remedy externalities with market-based policies?
By providing incentives so that private decision makers will choose to solve the problem on their own.
What are corrective taxes?
Taxes enacted to correct the effects of negative externalities. Also called Pigovian taxes.
Why do economists usually prefer corrective taxes over regulation?
Because such taxes can reduce pollution at a lower cost to society.
What is the essence of corrective taxes?
The corrective tax places a price on the right to pollute. Just as markets allocate goods to those buyers who value them most highly, a corrective tax allocates pollution to those factories that face the highest cost of reducing it.
Why do economists argue that corrective taxes are better for the environment than regulation?
Under the command-and-control policy of regulation, the factories have no reason to reduce emission further once they’ve reached the target. By contrast, the tax gives the factories an incentive to develop cleaner technologies, because a cleaner technology would reduce the amount of tax the factory has to pay.
How are corrective taxes unlike other taxes?
Corrective taxes alter incentives to account for the presence of externalities and thereby move the allocation of resources closer to the social optimum. Thus, while corrective taxes raise revenue for the government, they also enhance economic efficiency.
Describe a type of environmental tax shift due to corrective taxes.
The tax revenue from a higher gasoline tax could be used to lower other taxes that distort incentives and cause deadweight losses.
Why are tradeable pollution permits a favorable market-based policy?
The deal must make the owners of the two factories better off because they’re voluntarily agreeing to it. Moreover, the deal doesn’t have any external effects because the total amount of pollution remains the same. The same logic applies to any voluntary transfer of the right to pollute from one firm to another.
Why would a market for tradeable permits naturally develop?
If environment Canada allows firms to make these deals, it will have created a new scarce resource: Pollution permits; and a market to trade these permits will eventually develop to efficiently allocate such scarce resources, whatever the initial allocation.
How does the invisible hand ensure that the market for tradeable pollution permits allocate the right to pollute efficiently?
The firms that can reduce pollution only at a high cost will be willing to pay the most for the pollution permits. The firms that can reduce pollution at low cost will prefer to sell whatever permits they have.
What do corrective taxes and pollution permits have in common?
Both corrective taxes and pollution permits internalize the externality of pollution by making it costly for firms to pollute.
Describe how corrective taxes internalize the externality graphically.
A corrective tax (horizontal line) sets the price of pollution which, together with the demand curve, determines the quantity of pollution.
Describe how pollution permits internalize the externality graphically.
Pollution permits (vertical line) set the quantity of pollution which, together with the demand curve, determines the price of pollution.
Why is the supply curve for pollution rights perfectly inelastic with pollution permits?
Because the quantity of pollution is fixed by the number of permits.
Why is the supply curve for pollution rights perfectly elastic with corrective taxes?
Because firms can pollute as much as they want by paying the tax.
When is selling pollution permits more effective than levying a corrective tax and why?
When Environment Canada doesn’t know the demand curve for pollution, they can’t tell what size tax would achieve their goal.
In what ways is a clean environment a good like other goods?
Like all normal goods, it has a positive income elasticity: Rich countries can afford a cleaner environment than poor ones and, therefor, usually have more rigorous environmental protection. In addition, like most other goods, clean air and water obey the law of demand: The lower the price of environmental protection, the more the public will want.
How is the problem of extrnalities sometimes solved with moral codes and social sanction, and how does government try to encourage such solutions?
Another private solution to externalities is charities, many of which are established to deal with externalities.
The government encourages this private solution to externalities through the tax system by allowing an income tax deduction for charitable donations.
How else is the problem of extrnalities sometimes solved privately by firms?
- Sometimes the solution takes the form of integrating different types of businesses. Internalizing externalities is one reason why some firms are involved in more than one type of business.
- Another way for the private market to deal with external effects is for the interested parties to enter into a contract.
What is the Coase Theorem?
The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.
When does the Coase theorem apply?
Only when the interested parties have no trouble reaching and enforcing an agreement.
