Week 12: Externalities Flashcards
Externality
A cost or benefit of an action that falls on someone other than the person or firm choosing the action
Negative externality
An externality that imposes a cost
Positive externality
An externality that provides a benefit
When do negative and positive externalities arise?
Production and consumption activities
Negative production externalities
Billions of tonnes of pollutants in air, oceans, lakes, and rivers; climate change and global warming; CO2 emitted from the burning of fossil fuels to generate electricity and power vehicles
Negative consumption externalities
Plastic waste created when we throw a water bottle, shopping bag, container, or other packages in garbage bins and a source of irritation
Positive production externalities
A source of huge improvements in well-being that arise from a well-educated workforce: new technologies like the iPhone, renewable and green energy sources to counter negative production externalities of carbon fuel
Positive consumption externalities
When one person’s consumption benefits other people like flu vaccinations and education
Infection externalities
All four externality types can arise in a pandemic
Negative infection externalities
Infectious disease spreads through social interaction during production and consumption activities
Positive infection externalities
Limiting the spread through legally enforced public health regulations like a stay-at-home order
Private cost
Cost of producing a good or service that is borne by the producer
Marginal private cost (MC)
Cost of producing an additional unit of a good or service that is borne by its producer
External cost
Cost of producing a good or service that is not borne by the producer but borne by other people
Marginal external cost
Cost of producing an additional unit of a good or service that falls on people other than the producer
Marginal social cost (MSC)
Marginal cost incurred by the producer and by everyone else on whom the cost falls
How do you solve for marginal social cost?
Sum of marginal private cost and marginal external cost
How are external costs valued?
Economists use market prices to put a dollar value on the external costs of pollution
What does the marginal cost curve describe?
The marginal private cost which increases as the output produced increases
What does a point on the marginal social cost curve show?
The sum of the marginal private cost and the marginal external cost at a given level of output
What does the gap between MC curve and MSC curve represent?
Marginal external cost which increases with amount of output produced
S= MC and D=MSB=MPB
The marginal private cost curve is the market supply curve and the market demand curve is the marginal social benefit curve
Where does the inefficient market equilibrium occur due to an external cost?
Where S=D or MC=MSB
Where does the efficient equilibrium occur in a market with negative externality?
Where D or MSB is equal to MSC
Why is there inefficient overproduction at the inefficient market equilibrium in a market with negative externality?
Marginal social cost exceeds marginal social benefit
What is the area of the deadweight loss triangle created by an external cost?
Measures the society’s loss when there’s inefficient overproduction and external cost (pollution) is created
Why does the deadweight loss arise in a market with negative externality?
Firms only take their private cost into account when making their production decision
Three approaches to fixing the inefficiency created by an external cost
Establish property rights, mandate clean technology, and tax or price pollution
Property rights
Legally established titles to the ownership, use, and disposal of factors of production and goods and services that are enforceable in the courts; a foundation stone of the market economy but they don’t apply to all property
What can establishing property rights do?
Confront producers with the costs of their actions and provide incentives that allocate resources efficiently
Two possible responses to the cost of producing goods and creating pollution
Use an abatement technology or produce less and pollute less
Abatement technology
A production technology that reduces or prevents pollution from electricity generation and many industrial processes
Produce less and pollute less
An alternative to incurring the cost of abatement technology is to use the polluting technology but cut production, reduce pollution, and get a higher income
How do firms decide whether to use abatement technology or produce less?
Firms will choose the least-cost alternative
What costs do producers face with property rights in place?
Producers face the pollution or abatement costs, whichever is lower, and the cost of production
What is the market supply curve with property rights in place?
MSC curve, labelled S=MC=MSC, includes the cost of producing plus the cost of pollution (external cost) or the cost of abatement, whichever is lower