Week 6 - Externalities & Public goods Flashcards
Externality
An action by an agent (a person/firm) that affects someone other than that agent
Positive consumption externality
When person B’s consumption of good x increases utility of person A
- when x^B increases, utility of person A also increases
- although they couldn’t choose/consume x^B
Negative consumption externality
When person B’s consumption of good X decreases person A’s utility
- when x^B increases, utility of person A decreases
- although they couldn’t choose/consume x^B
Utility externality
If person B’s utility directly affect person A’s utility (not dependant on a good x anymore)
Easterlin paradox
- Higher income in the US correlates well w/ higher happiness. However, at some point of income level, happiness stops increasing.
- Later studies suggested that higher income does correlate with higher happiness, but at a decreasing rate (concave)
Production externality
When a firm’s production affects people or other firms who are not directly involved in their production processes
Pareto efficiency
An outcome where no one can be made better off w/o making someone else worse off (welfare maximisation)
Social welfare
Sum of consumer + producer surplus
*& think about the deadweight (efficiency) loss created by the externality
What does the demand curve P(Q) tell us?
The MARGINAL BENEFIT ppl get from consuming a good.
- Maximum willingness to pay, how much a consumer is willing to pay to get the xth unit of the good
Marginal social cost of production formula
*supply curve = marginal private cost, & demand curve = marginal private benefit
MSC = Marginal private cost (MPC) + External marginal cost (EMC)
Deadweight loss due to externality
The loss we get from a competitive market (rather than efficient market)
Avoidable, eg. noise pollution, climate change
Coase theorem + 3 issues
With NO TRANSACTION COST & NO HIDDEN INFORMATION, if property rights are fully assigned parties will bargain to reach the efficient outcome.
- The “only” consequence of assigning property rights to an agent is on the incomes of the agents involved
Issues:
1. We need parties to be able to bargain - hard to bargain with a multinational vs small firm
2. Efficient bargaining requires perfect information - to know the efficient level of production
3. Income effects of assigning rights may not be small - what if producers get richer vs poor ppl in deprived areas
How do (government) quotas work?
- If govt knows/can estimate the efficient outcome, they can impose limits on production.
- Set the quota (maximum production) to be = Q^e so firms won’t be able to produce more
^quotas often assigned based on past performance -> bad dynamic incentives
- Quotas and price floors can create black markets
Price floors (and ceilings)
The minimum price at which firms can sell a product.
- Set price to efficient level p^e so that demand will stop at Q^e…
- …to ensure ppl don’t demand more of the product with negative production externality
(have to be really sure about the efficient price first)
In principle, price floors can restore efficiency but creates incentive for suppliers to sell more & willing to sell at lower price to increase demand
Pigouvian tax
A PER-UNIT tax on producers equal to the EMC of production at the EFFICIENT level of output
