Week 9 - Externalities

Question 1

What is an externality?

Answer 1

An externality involves uncompensated impacts on unrelated 3rd parties.

Question 2

What is a positive consumption externality?

Answer 2

Marginal private benefit is greater than marginal social benefit. Marginal private cost = marginal social cost.

In this case, the deadweight loss is the area e + f between the efficient and market quantity and the two demand curves

Question 3

What is a negative consumption externality

Answer 3

Marginal private benefit is above marginal social benefit. MPC=MSC.

Deadweight loss is the are I, on the right side of the supply curve and between the demand curves.

Question 4

What is a positive production externality

Answer 4

Marginal Private cost is greater than marginal social cost. Private and social benefit are equal.

Deadweight loss is the are E+I between Qe Qm and demand.

Question 5

What is a pigouvian tax/subsidy

Answer 5

Rate at which activity is reduced from the market quantity to the efficient rate (when people consider society’s benefit/cost).

Question 6

What is the Coase Theorem?

Answer 6

The coase theorem is the proposition that if private parties can be bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

Only applies when interested parties can easily reach and enforce an agreement. In other cases regulation may be necessary, preferable with market based policies.

Question 7

Why is the optimum level the place where social benefit/cost and the other curve meet

Answer 7

Below Qe, the value of the good to consumers exceeds the social cost of production. Above Qo, the social cost exceeds the benefit.

The gov can internalise externalities by taxing activities with negative externalities and subsidising positive externalities. This moves the allocation of resources closer to the optimum, improving efficiency