Part 4 [The Economics of the Public Sector] - 10. externalities - 11. public goods and common resources - 12. the design of the tax system Flashcards
1
Q
What is an externality?
A
The uncompensated impact of one person’s actions on the well-being of a bystander.
2
Q
What is the difference between a negative and positive externalities?
A
Negative externalities have adverse effects.
Positive externalities have beneficial effects.
3
Q
Why are market equilibriums not efficient when there are externalities?
A
Because buyers and sellers neglect the external effects of their actions when deciding how much to demand or supply.
4
Q
How does the cost curve appear in the presence of a negative externality?
A
As a social cost curve above of, and parallel to the private cost curve.
5
Q
Why would a social planner chose the level of production at which the demand curve crosses the social-cost curve?
A
This intersection determines the optimal amount from the standpoint of society as a whole.
6
Q
Why is Qmarket larger than the Qoptimum in the presence of negative externalities?
A
In the market equilibrium, the marginal consumer values the good less than the social cost of producing it.
7
Q
How is producer surplus measured in the presence of a negative externality?
A
The amount received by sellers minus the social costs of production (which include the private costs and social costs)
8
Q
How do we graphically represent the loss of total surplus due to a negative externality?
A
As the area of the triangle formed by the social cost curve and the demand curve between Qoptimum and Qmarket.
9
Q
What does the height of the social-cost curve in the presence of a negative production externality incorporate?
A
The seller’s private costs of production plus the social-cost imposed on others due to the negative externality.
10
Q
How can a social planner achieve the socially optimal level of production and eliminate the deadweight loss associated with the externality?
A
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.
11
Q
Why is a tax used to correct negative externalities?
A
to force producers to internalize the externality.
12
Q
What does it mean to internalize the externality?
A
To alter incentives so that people take account of the external effects of their actions.
13
Q
What 3 ways does education yield positive externalities?
A
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.
14
Q
How does the social-value curve appear in the presence of a positive externality?
A
Because the social value is greater than the private value, the social-value curve lies above and parallel to the demand curve.
15
Q
How does a social planner move the market equilibrium closer to the social optimum when there are positive externalities?
A
With subsidies.
16
Q
Summarize the analysis of externalities.
A
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.
17
Q
What is industrial policy?
A
Government intervention in the economy that aims to promote technology-enhancing industries.
18
Q
Apart from industry policy, what is another way to encourage technological advances?
A
With patent protection.
19
Q
What two types of policy can government use to respond to externaliies?
A
- Command-and-control policies
- Market-based policies
20
Q
How does the government remedy externalities with command-and-control policies?
A
Through regulation.
21
Q
What do government need to know in order to properly regulate a market?
A
The details about specific industries and about the alternative technologies that those industries adopt. This information is often difficult for government regulators to obtain.
22
Q
How does the government remedy externalities with market-based policies?
A
By providing incentives so that private decision makers will choose to solve the problem on their own.
23
Q
What are corrective taxes?
A
Taxes enacted to correct the effects of negative externalities. Also called Pigovian taxes.
24
Q
Why do economists usually prefer corrective taxes over regulation?
A
Because such taxes can reduce pollution at a lower cost to society.
25
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.
26
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.
27
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.
28
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.
29
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.
30
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.
31
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.
32
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.
33
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.
34
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.
35
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.
36
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.
37
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.
38
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.
39
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.
40
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.
41
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.
42
When does the Coase theorem apply?
Only when the interested parties have no trouble reaching and enforcing an agreement.
43
Why do interested parties sometimes fail to solve an externality problem despite the Coase theorem?
- Because of transaction costs: translators, lawyers, etc...
- When bargaining simply breaks down.
- When the number of interested parties is large.
44
What are transaction costs?
The costs that parties incur in the process of agreeing and following through on a bargain.
45
What is often the reason for why bargaining might break down?
The problem is often that each party tries to hold out for a better deal.
46
Why does private solutions to externalities sometimes fail when the number of interested parties is large?
Because coordinating everyone is costly.
47
When can government policy potentially remedy a market failure and raise economic well-being?
When a good doesn't have a price attached to it, because private markets can't ensure that the good is produced and consumed in the proper amounts.
48
Which two characteristics is it useful to group the various goods in the economy?
- Excludability
| - Rival in Consumption
49
What is excludability?
The property of a good whereby a person can be prevented from using it.
50
When is "rival in consumption"?
The property of a good whereby one person's use diminishes other people's use.
51
What are private goods?
Good that are both excludable and rival in consumption.
52
What are public goods?
Goods that are neither excludable nor rival in consumption.
53
What are common resources?
Goods that are rival in consumption but not excludable.
54
What is a natural monopoly?
Goods that are excludable but not rival in consumption.
55
What is a free-rider?
A person who receives the benefit of a good but avoids paying for it.
56
What is the free-rider problem?
Because public goods are not excludable, people have an incentive to be free-riders and the market would fail to produce an efficient outcome.
57
What is the general lesson about public goods?
Because public goods are not excludable, the free-rider problem prevents the private market from supplying them. If the government decides that the total benefits exceed the costs, it can provide the public good and pay for it with tax revenue, making everyone better off.
58
What are 3 important public goods?
- National defence
- Basic research
- Fighting poverty
59
What is cost-benefit-analysis?
A study that compares the costs and benefits to society of providing a public good.
60
Why is the efficient provision of public goods intrinsically more difficult than the efficient provision of private goods?
Cost-benefit analysts don't observe any price signals when evaluating whether the government should provide a public good. Their findings on the costs and benefits of public projects are, therefore, rough approximations at best.
61
How can we deduce that human life doesn't have an infinite dollar value.
In both our public and private decisions, we are at times willing to risk our lives to save some money. There aren't traffic lights at every corner and people sometimes choose to buy small cars without side-impact air bags or antilock brakes.
62
Why do economists, unlike courts, not calculate the value of a person's life based on how much money they would've earned in the remainder of their lifetime?
Because it has the bizarre implication that the life of a retired or disabled person has no value.
63
How do economists prefer to put a dollar value on someone's life?
By looking at the risks that people are voluntarily willing to take and how much they must be paid for taking them. By comparing wages in risky and less risky occupations, controlling for education, experience, and other determinants of wages, economists can get some sense about what value people put on their own lives.
64
What is the tragedy of the commons?
A parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole.
65
What lies behind the tragedy of the commons?
The fact that social and private incentives differ.
66
What general lesson can be learned from the tragedy of the commons?
when one person uses a common resource, that person diminishes other people's enjoyment of it. Because of this externality, common resources tend to be used excessively. The government can solve the problem by reducing use of the common resource through regulation or taxes. Alternatively, the government can sometimes turn the common resource into a private good.
67
What are 3 important common resources?
- Clean air and water
- Congested roads
- Fish, Whales, and other wildlife
68
When are roads a public good and when are they a common resource?
Public good: when not congested
| Common resource: when congested.
69
Which two problems prevent an easy solution to the depletion of fish, whales, and wildlife?
- Many countries have access to the oceans, so any solution would require international cooperation among countries that hold different values.
- Because oceans are so vast, enforcing any agreement is difficult.
70
What is the common theme in the struggle to properly allocate public goods and common resources?
The fact that property rights for these goods aren't well established.
71
How do most people agree taxes should be?
Most people agree that taxes should impose as small a cost on society as possible and that the burden of taxes should be distributed fairly. That is, the tax system should be both efficient and equitable.
72
Describe Canada's federalist structure.
Political power is divided between the federal government and the provincial and territorial governments, with greater power going to the federal government. The third level of government is granted powers by the provincial and territorial governments.
73
Briefly describe some of the federal government's responsibilities.
The federal government is responsible for matters of national interest, including national defense and foreign policy, international trade, competition policy, criminal law, and money and banking. This level of government has essentially unlimited taxing powers.
74
Briefly describe some of the provincial government's responsibilities.
The provinces and territories are responsible for the areas of health care, education, welfare, natural resources within their boundaries, and civil law. The provinces and territories have extensive taxing powers, although they are less extensive than the federal government's.
75
What is an important aspect of our federalist government structure?
The role of transfers from the federal government to the provinces and territories. Although he federal government isn't directly responsible for programs related to health, education, and welfare, it has been able to exercise substantial influence in these areas through the "power of the purse".
76
What are the most important transfer programs in Canada?
The Canada Social Transfer (CST) and the Canada Health Transfer (CHT).
They are both largely unconditional per capita grants that simply enter general provincial and territorial government revenues and may be used as these governments see fit.
77
What is the CST for?
Funding for programs in post-secondary education, social services (welfare), and early childhood development.
78
What is the CHT for?
Financing health programs
79
Describe the important role of equalization payments
The federal government provides general-purpose transfers to the "have-not" provinces so that they can provide services that are roughly comparable in quality to those provided by the "have" provinces.
80
About what percentage of Canadian taxes are collected by the federal government?
40%
81
List the sources of revenue for the federal government from largest to smallest.
- The personal income tax
- Taxes on goods and services: The Goods and Services Tax (GST), Excise taxes (taxes on specific goods), Customs duties
- Corporate income tax
- Payroll tax
82
87% of federal government spending is devoted to program spending. Which is the single largest category of federal expenditures, aside from debt repayment?
Payments to elderly people under the Old Age Security program. (14% of total spending)
83
About what percentage of Canadian taxes are collected by provincial governments?
60%
84
List the sources of revenue for the federal government from largest to smallest.
- Personal income tax
- Provincial sales taxes
- Corporate income tax
- Provincial health premiums
- Payroll tax.
85
Which 3 are the largest categories of provincial expenditures, aside from debt repayment?
Health, Education, and Social services.
86
After the big three, which 4 are the largest categories of provincial expenditures, aside from debt repayment?
- Police and protection
- Transportation and communication
- Resource conservation
- Industrial development
87
What is an efficient ta system?
One that imposes small deadweight losses and small administrative burdens.
88
Describe some of the deadweight looses due to the administrative burdens of our tax system.
This burden includes not only the time spent in April filling out forms but also the time spent throughout the year keeping records for tax purposes and the resources the government has to use to enforce the ta laws.
89
What is an average tax rate?
Total taxes paid divided by total income.
90
What is the marginal tax rate?
The extra taxes paid on an additional dollar of income.
91
The marginal and average tax rates each contain a useful piece of information. When is the average tax rate more insightful?
If we are trying to gauge the sacrifice made by a taxpayer, the average tax rate is more appropriate because it measures the fraction of income paid in taxes.
92
The marginal and average tax rates each contain a useful piece of information. When is the marginal tax rate more insightful?
If we are trying to gauge how much the tax system distorts incentives, the marginal tax rate is more meaningful. The marginal tax rate measures how much the tax system discourages people from working, therefore, determining the deadweight loss of an income tax.
93
What is a lump-sum tax?
A tax that is the same amount for every person.
94
Why is a lump-sum tax the most efficient?
Because a person's decisions do not alter the amount owed, the tax doesn't distort incentives and, therefore, doesn't cause deadweight losses. Because everyone can easily compute the amount owed and because there is no benefit to hiring tax lawyers or accountants, the lump-sum tax imposes a minimal administrative burden on taxpayers.
95
If lump-sum taxes are so efficient, why do we rarely observe them in the real world?
Because it would take the same amount from the poor and rich, an outcome most people would view as unfair.
96
What is the benefits principle of taxation?
The idea that people should pay taxes based on the benefits they receive from government services.
97
What does the benefits principle of taxation try to accomplish?
This principle tries to make public goods similar to private goods. A person who gets great benefit from a public good should pay more for it than a person who gets little benefit.
98
Describe a great example of the benefits principle in action.
In some provinces, revenues from the gasoline tax are used to build and maintain roads. Because those who buy gasoline are the same people who use the roads, the gasoline tax might be viewed as a fair way to pay for this government service.
99
What is the ability-to-pay principle of taxation?
The idea that taxes should be levied on a person according to how well that person can shoulder the burden.
100
What is vertical equity?
The idea that taxpayers with a greater ability to pay taxes should pay larger amounts.
101
What is horizontal equity?
The idea that taxpayers with similar abilities to pay taxes should pay the same amount.
102
What is a proportional tax?
A tax for which high-income and low-income taxpayers pay the same fraction of income.
103
What is a regressive tax?
A tax for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.
104
What is a progressive tax?
A tax for which high-income taxpayers pay a higher fraction of their income than do low-income taxpayers.
105
What is central to evaluating tax equity?
Tax incidence. Because taxes alter supply and demand, they alter equilibrium prices. As a result, they affect people beyond those who, according to statute, actually pay the tax.
106
Talk about the seductive allure of corporate taxes.
Many economists believe that workers and customers bear much of the burden of the corporate income tax. The corporate income tax is popular in part because it appears to be paid by rich corporations. Yet those who bear the ultimate burden of the tax - the customers and workers of corporations - are often not rich.
