Task 5: Environmental Externalities Flashcards
What are externalities in economics?
Externalities are unintended spillover effects of economic activities that affect third parties who are not involved in the transaction, leading to social costs or benefits not reflected in market prices.
How do externalities lead to market failure?
Externalities result in market failure when private costs or benefits differ from social costs or benefits, causing overproduction of goods with negative externalities and underproduction of those with positive externalities.
What is the significance of internalizing externalities?
Internalizing externalities involves adjusting prices to reflect true costs, helping to achieve efficient market outcomes and promote social welfare by aligning private incentives with social impacts.
What is the Coase Theorem?
The Coase Theorem states that if property rights are well-defined and transaction costs are low, parties can negotiate efficient outcomes regarding externalities, regardless of who holds the rights.
What are some limitations of the Coase Theorem?
Limitations include unrealistic assumptions about zero transaction costs, challenges like the free rider effect and holdout effect when multiple parties are involved, and neglect of equity issues, particularly for low-income communities.
What is optimal pollution?
Optimal pollution refers to the level of pollution that occurs at the socially optimal equilibrium after externalities have been internalized, balancing social costs and benefits.
What challenges exist in achieving optimal pollution?
Challenges include difficulties in valuing externalities and time delays between changes in demand and supply, which may lead to over-supply or under-supply of resources.
How does the law of demand relate to environmental externalities?
The law of demand indicates that as prices decrease, demand increases; however, when external costs are not reflected in prices, consumers may demand more than is socially optimal.
What role do command-and-control measures play in internalizing externalities?
Command-and-control measures regulate production processes directly to reduce negative externalities by imposing limits or standards, effectively shifting supply curves to achieve social optimum.
What is a Pigouvian tax?
A Pigouvian tax is a tax imposed on producers equal to the external cost of their production, incentivizing them to reduce output to a socially optimal level.
How do subsidies help internalize positive externalities?
Subsidies lower production costs for goods with positive externalities, shifting the demand curve rightward to encourage increased consumption and production towards a social optimum.
What is welfare analysis in the context of externalities?
Welfare analysis examines the benefits gained by consumers and producers in a market, assessing how changes (like taxes) impact consumer surplus, producer surplus, and overall net benefits.
How can environmental policies achieve social optimum?
Policies such as Pigouvian taxes or subsidies can shift supply and demand curves to align private incentives with social welfare, reducing overproduction or underproduction caused by externalities.
What are external costs and benefits in economic activities?
External costs are negative impacts incurred by third parties not involved in an economic transaction, such as health issues from pollution. External benefits are positive effects enjoyed by third parties, like improved air quality from a community park. Both are not reflected in market prices, leading to potential overproduction of goods with external costs and underproduction of those with external benefits.
How do external costs and benefits contribute to market failure?
When external costs are present, producers may overproduce since prices only reflect their production costs, ignoring social costs. Conversely, when external benefits occur, goods may be underproduced because producers aren’t fully compensated for the social benefits they provide. This misalignment results in market failure, as the true social costs and benefits of consumption are not accurately captured.
