Week 9 (GPT) Flashcards
What is an externality?
A cost or benefit from production or consumption that affects a third party not directly involved in the market transaction.
What are the four types of externalities?
Positive consumption, negative consumption, positive production, negative production.
Give examples of positive consumption externalities
Education, exercise, vaccination.
Give examples of negative consumption externalities
Secondhand smoke, loud music on public transport.
Give examples of positive production externalities
R&D, job training, tech innovation.
Give examples of negative production externalities
Pollution, overfishing, excess carbon emissions.
What is the Coase Theorem?
If rights are defined and there are no transaction costs, bargaining can lead to efficient outcomes regardless of who holds the rights.
Key assumptions of the Coase Theorem?
Defined rights, rational actors, low transaction costs, complete information, small number of parties.
Why doesn’t the Coase Theorem work in large markets?
Too many parties and high transaction costs make negotiation impractical.
What does it mean to internalize an externality?
Adjusting incentives so private actors bear the external costs or benefits.
What happens with a positive externality in a free market?
The good is underprovided relative to the socially optimal quantity.
What happens with a negative externality in a free market?
The good is overprovided compared to the socially optimal level.
How can governments fix a positive externality?
Offer subsidies equal to the marginal external benefit.
How can governments fix a negative externality?
Apply a tax equal to the marginal external cost.
What is deadweight loss in externality markets?
Lost surplus due to inefficient market outcomes.
How does a positive externality create deadweight loss?
From underconsumption of beneficial goods.
How does a negative externality create deadweight loss?
From overproduction of harmful goods.
What does Q* represent in externality analysis?
The socially optimal quantity where marginal benefit equals marginal cost.
What shifts in demand occur with positive externalities?
The social demand curve lies above the private demand curve.
What shifts in supply occur with negative externalities?
The social supply curve lies above the private supply curve.
What is marginal social benefit (MSB)?
Total benefit to society, including both private and external benefits.
What is marginal social cost (MSC)?
Total cost to society, including private and external costs.
What is a Pigouvian tax?
A tax used to correct negative externalities by internalizing the cost.
What is a Pigouvian subsidy?
A subsidy used to correct positive externalities by internalizing the benefit.
Why are vaccines underprovided in a free market?
People ignore the benefit to others when deciding whether to vaccinate.
Why do polluting industries overproduce in free markets?
They don’t account for the harm to others, only private cost.
What does a carbon tax do?
It charges firms for pollution to internalize the social cost.
How do taxes affect the supply curve?
They shift the supply curve upward (or left), decreasing quantity.
How do subsidies affect demand or supply?
They shift demand or supply curves to the right, increasing quantity.
What is a public good?
A good that is non-rival and non-excludable.
What does non-rival mean?
One person’s use does not reduce availability for others.
What does non-excludable mean?
People can’t be prevented from using the good even if they don’t pay.
Give examples of public goods
National defense, street lighting, public fireworks shows.
Why don’t markets provide public goods efficiently?
Because of the free rider problem.
What is the free rider problem?
People benefit from a good without paying, leading to underprovision.
Why is a public bus not a true public good?
It is excludable and rival — limited seating and requires payment.
What is the Samuelson condition?
The efficient provision of a public good occurs where the sum of individual marginal benefits equals marginal cost.
What is the socially optimal provision of public goods?
Where marginal social benefit equals marginal cost.
What is the Lindahl pricing rule?
Each person pays for public goods according to their marginal benefit.
Why doesn’t Lindahl pricing work in reality?
People won’t truthfully reveal how much they value the good.
What does underprovision mean?
Less of the good is produced/consumed than is socially optimal.
What causes underprovision in public goods?
Free riders benefiting without paying discourage private provision.
Why might the government provide streetlights?
Because they are a public good and the market won’t provide them efficiently.
What is the goal of government intervention with externalities?
To align private decisions with social efficiency.
How do you calculate deadweight loss from underprovision?
½ × external benefit × underprovided quantity.
How do you calculate deadweight loss from overproduction?
½ × external cost × overproduced quantity.
