Topic 4 - Markets, Externalities, and Public Goods (2)

Question 1

The Coase Theorem

Answer 1

Way to internalize an externality; a proposition that if property rights are clearly defined and transaction costs are low, then private bargains will solve the problem of externalities and ensure efficient market equilibrium.

Question 2

Command-and-Control Policies

Answer 2

Policies that regulate behaviour directly; involves the government imposing quantitative limits or other regulations to regulate production externalities affecting society.

Question 3

Market-Based Policies

Answer 3

Provide incentives so private decision makers will choose to solve the problem on their own; things such as corrective taxes and subsidies, and tradable pollution permits.

Question 4

Pigovian Tax - why is it called a “Double Dividend of Taxation”?

Answer 4

Tax on a good that is enacted to correct the effects of negative externalities coming from the production of that good.
It increases efficiency and brings in tax revenue for the government, which is why it’s called a double dividend of taxation.
Helps internalize the externality because it makes producers consider external factors.

Question 5

Subsidies

Answer 5

Imposed on products or activities that have positive externalities.
Subsidy that is equal to the marginal external benefit can help achieve an efficient outcome.
A subsidy is a payment by the government to private producers.

Question 6

Cap-and-Trade and Pollution Quotas

Answer 6

Cap and trade - concept of tradable pollution permits
Pollution quota - a limit (cap) set on how much pollution each firm is allowed to produce
Allows for efficient allocation, as the pollution permits will have their own market and allocate themselves efficiently.

Question 7

Excludability

Answer 7

A good is excludable if only the people paying for it are able to enjoy its benefits.
A good is non-excludable if it is impossible (or extremely costly) to prevent anyone from benefiting from it.
Non-excludability is the main reason of market failure.

Question 8

Rivalry

Answer 8

A good is rival if one person’s use of it decreases the quantity available for someone else.
A good is non-rival if one person’s use of it does not decrease the quantity available for someone else.

Question 9

Four Categories of a Good

Answer 9

Public - non-excludable and non-rival
Private - excludable and rival
Common resource - non-excludable and rival
Club good - excludable and non-rival

Question 10

Value of a Public Good

Answer 10

The maximum amount that all consumers are willing to pay for one more unit of the good.

Question 11

Aggregate Demand Curve for a Public Good

Answer 11

Determined by adding vertically the price at which each consumer is willing to pay for each quantity of a good.
MWTP aggregate = MWTP (A) + MWTP (B)

Question 12

Efficient Quantity of a Public Good

Answer 12

MSB = MSC

Question 13

Lindahl Pricing

Answer 13

Individuals pay for the public good according to their marginal benefits.
Difficult to implement due to the problems associated with preference revelation, preference knowledge, and preference aggregation.

Question 14

Tragedy of the Commons

Answer 14

The overconsumption of common goods from the standpoint of society as a whole, as they are non-excludable but rival in nature.
This is a negative externality.

Question 15

Individual Transferable Quotas

Answer 15

A production limit that is assigned to an individual who is free to transfer (sell) the quota to someone else.
Helps achieve a more efficient use of a common resource.
MSC=MC+ITQ Price

Question 16

Property Rights

Answer 16

Help convert common resource into private property; causes MSC curve to become the supply curve, and the resource gets used more efficiently.