Topic 10- Externalities Flashcards
Externalities
When a market activity creates side-effects that impact bystanders who are NOT part of the trade that takes place
What do externalities do to the market
They shift the supply/demand (cost/benefit) curves so the market is no longer efficient
How are externalities addressed
By government policies
Types of Externalities
Positive
Negative
Negative Externality
An adverse side effect, it adds to the COST of producing a specific good; producing paper includes deforestation, so even though the paper amrket migth alledgly achieve equilibrium, the supply (cost) curve would dhift up and then the equilbirum with the REAL cost would no longer be efficient
real cost curve= social cost
what is the real cost after considering externality curve called?
Social cost curve
Using the disagram of supply demand, what areas are what in negative externality
- shift the curve that you need to (cost curve)
2.shade consumer surplus & producer surplus (even thos prod is weird)
3.highlight the dead weight loss, this is the overproduction that is being done ABOVEEE the market equilbbrium - consider what changed and what is the same <3
Positive externality
causes excess marginal benefit to others who are not part of it
educatioin
public historic building
What curve does positive externality shift
marginal beenfit curve
what do negative externalities do and what do psotivie externalities do
Negative externalities cause society to produce more than socialy desirable (excess deforestation)
postiive externalities cause society to produce less than socially desirable underproduction)
UNDERPRODUCTION
overproduction
Positive externality
negative externality
What is the goal of regulations against externalities
To move the market equilibrium to what is the social optimum equilbrium
Two types of government regulation response policies
- commang and control: regulate behaviour by law
- market based policies: incentivize individuals to solve problems
Types of market based policies
Corrective Tax
tradable pollution permits
Corrective Tax/Pigovian Tax
negative externality ?
Respond to negative externalities (pollution)
the goal is to make the actual supply curve match the social cost curve
called “internalizign the externality” forcing producers/ consumers to take the social cost into account when purchasing/producing!
Correcitve Subsidies
Respond to positive externalities
GOVT subsidizes the cost of education to move to social optimum !
What do corrective taxes do
They make the eocnomy more efficient by putting a price on the right to pollute
and they do not create deadweight loss because they are fixing a broken equilibrium
Command and control policies
Make behaviours illegal by law
difficult because society has to pick and choose whcih behaviours are illegal, and this is especially an issue when the matter of concrn is difficult, such as pollution
Market based policy: tradable pollution permits
Basically turning the right to pollute into a tradable currency (A scarce resource!!!) companies trade pollution permits among each other AND THIS CREATES ECONOMIC EFFICIENCY:
firms who treasure the right to pollute will get permit (ALLOCATIVE EFFICIENCY)
FIRMS THAT CANNOT REDUCE POLLUTION AT A LOW COST WILL BUY THESE PERMITS!!
differences between tradable pollution permit and corrective taxes
elasticity?
BOTH MARKET BASED POLICIES BUT
corrective tax paid to the govt, tradable pollution permit value is paid to the other corporation that owns the permit
the elasticity of the corrective tax on pollution is PERFECTLY ELASTIC (horizontal) bc if firms pay the tax they can pollute as much as they want!
the elasticity of the tradable pollution permits is PERFECTLY INELASTIC SUPPLY (bc only a limited amount of the good is made)
Environmental pollution scenario: if the country does not know the demand curve for pollution, should it levy a tax on the polluters or should they release trading permits?
TRADING PERMITS BC IT IS MORE PRECISE AND EASY TO CONTROL
THE AUCTION PRICE FOR THESE PERMITS WOULD REVEAL THE SIZE OF THE TAX
Private solution to externalities
CHARITIES!
FINANCIAL DONATIOS TO SCHOOLS
ONE FIRM doing multiple forms of business (keeping bees and keeping apple orchards)
Contracts (Coase Theorem)
Coase Theorem
rights, transcation, knowledge
if property rights are clearly
defined
and transactions costs are low,
and Parties have full information about the costs and benefits involve
then private bargains will solve
the problem of externalities and ensure that the market equilibrium is
efficient
Coase theorem in practice
if Person A does not like Person Bs act, A can pay B to change; Marginal benefit for B must exceed the marginal cost of continuing to do this action!
Is coase theorem superior or is the law?
Coase theorem is superior bc it doesn;t matter hwo is given the legal right to do what, if private parties cna simply pay each other to act a certain way!
Why does coase theorem not always work even when both can be better off
- transaction costs are too high (costs when intially trying to bargain! such as getting a translator)
- bargainign breakdwon because of semantics
internalizing the externality
externalityalter incentives so that people take account of the external effects of their actions
WHY DO CORRECTIVE/PIGOVIAN TAX NOT CAUSE DEADWEIGHT LOSS
because the loss to society is internalized within the tax (makes economy more efficient)
A negative externality imposes a cost, and a positive externality
creates a benefit
word
4 TYPES OF EXTERNALITIES
Negative production externality *pollution)
Negative consumption (smoking)
Positive Consumption
Positvie production (bees and apples)
nEGATIVE Consumption externality
common in every day
smokers
meth addicts
loud parties
positive production
less common but when production birngs benefit to others
Positive consumption allergies
benefit others and very common
VACCINES!
PRIVATE COST
marginal private cost
THE COST ONE INDIVIDUAL PAYS FOR A GOOD
the cost of consuming or producing one extra of that private good
External cost is a cost paid by bystanders, by people other than the
consumer or producer.
Marginal external cost is the cost of consuming or producing one
more unit of a good or service that falls on people other than the
consumer or produce
Marginal social cost and formula
The cost to society of that good
MSC=MC + Marginal external cost
Social surplus, when is it maximized
Bystander surplus + Producer surplus +consumer surplus
maximized when no significant external cost
how does marginal cost curve (supply) shift to amrginal socail cost curve
Marginal cost curve + margina lexternal cost = marginal social cost curve
what is socailly optimal quantity
where marginal scoail lbenefit curve= marginal social cost curve
Private benefit is a benefit that the consumer of a good or service
receives.
I Marginal private benefit (MB) is the private benefit from
consuming one more unit of a good or service.
I External benefit is a benefit that someone other than the consumer
receives.
I Marginal external benefit is the benefit from consuming one more
unit of a good or service that people other than the consumer enjoy
i
Marginal social benefit
benefit enjoyed by entire society (consumer and all)
MSB= MB+ MARGINAL EXTERNAL BEENFIT
What is the size correlation between externality and deadweight loss
the larger the externality the larger the deadweight loss
Ideal corrective tax?
equal the marginal external cost
associated with the activity that generates the negative externality
MC + TAX =MSC
cap-and-trade
name for tradable pollution permits
A government must first estimate the efficient
quantity of pollution and set the overall cap equal to that quantity.
efficient allocation: government needs to know each
firm’s marginal cost of production and marginal abatement cost.
(An abatement technology is a production technology that reduces or
prevents pollution)
Location of deadweight loss: positive externality
Below marginal social benefit curve and above price curve
Location of deadweight loss: negative externality
Below marginal social cost curve and above benefit curve
RULE OF THUMB FINDING DEADWEIGHTS FOR EXTERNALITIES
BELOW SOCIETAL ___ CURVE AND ABOVE THE OPPOSITVE TYPE OF CURVE!!
