welfare economic analysis

Question 1

what does welfare conomics attempt to do?

Answer 1

provide a framework in which normative judgements can be made about alternative configurations of economic activity
identify total costs and benefits of alternative policies to different groups and then make a decision according to some criteria
identify circumstances under which it can be claimed that one allocation of resources is better in some sense than another

Question 2

what are the steps of welfare economic analysis?

Answer 2

you need to compare two alternative configurations (1- negative externality is present but not considered , 2- negative externality is present and considered)
ranking alternatives according to some criterion ( allocative efficiency/pareto, max Net social benefit)
make a choice/recommendation

Question 3

what is the consumer surplus?

Answer 3

value that consumers receive from an allocation minus what it costs them to obtain it

Question 4

how is the consumer surplus shown graphically?

Answer 4

area under the demand curve and above the paid price

Question 5

what is producer surplus?

Answer 5

the value that producers recieve from an allocation minus what it costs them to obtain it

Question 6

how is the producer surplus shown graphically?

Answer 6

the area above the supply curve and below the received price

Question 7

what is the externality cost#?

Answer 7

the area between the social marginal cost curve and the private marginal cost curve

Question 8

what is the net social benefit with an externality?

Answer 8

the net social benefit with an externality is the consumer surplus plus the producer surplus minus the externality

Question 9

what is the free market outcome?

Answer 9

the free market operates where the marginal private cost equal the marginal private benefit. at this point there is a dead weight loss to society as between Q* and the actual Q the social marginal cost is greater then the private marginal costs

Question 10

what is the effect of a pigouvian tax?

Answer 10

a pigouvian tax will internalise the externality by shifting the marginal private cost curve up in order to be in line with the marginal social cost curve. the government will receive revenue through taxation and the externality will be decreased

Question 11

why is the optimal level of pollutoon not zero?

Answer 11

the only way to achieve zero pollution is to have zero production. so society must decide upon the acceptable level of pollution

Question 12

why might it be argued that economic analysis comes short when it comes to the optimal level externality?

Answer 12

the optimal level of pollution is dependent on the interactions between supply and demand, if the demand for cars increases then the demand curve will shift right and the optimal pollution level will increase. so if the demand for cars rises steadily will ever rising levels of pollution be acceptable. this should not be the the case. a maximum level of pollution should be based on other considerations rather than pure economic analysis such as health and ecological considerations

Question 13

what is the coase theorem?

Answer 13

it is a private bargaining solution for externalities between the party that causes the damage and the party that suffers the damage.
it states that if property rights are well defined and there are no transaction costs, an efficient allocation of resources will result even if externalities exist via private bargaining

Question 14

what are transaction costs?

Answer 14

costs associated with a market transaction, costs involved in reaching and implementing an agreement, costs of obtaining information, time and effort spent in negotiations and the costs of enforcing the agreement

Question 15

what are the two possbilities for the property rights in the coase theorem?

Answer 15

the property rights are in the hand of the polluter/perputrator and the property rights are in the hand of the victem

Question 16

what is the efficient solution in the coase theorem?

Answer 16

the marginal private benefit to the producer is equal to the marginal private cost to society

Question 17

assume the property rights are in the hands of the community, how is the efficient solution reached according to the coase theorem?

Answer 17

if the property rights are in the hands of the community then they decide how much pollution can be discharged. when there is no pollution in the water, there is very few marginal benefits to the community however there is high marginal benefits to the producer to produce a first unit. this creates an incentive to negotiate and therefore the company would pay the community to pollute more as long as the marginal private benefit to the company exceeded the marginal external cost to the community

Question 18

what is the net social welfare in the coase theorem when the property rights belong to the community?

Answer 18

the area below the marginal benefit curve but above the marginal cost to community curve

Question 19

assume the property rights are in the hands of the polluter, how is the efficient solution reached according to the coase theorem?

Answer 19

the company has the property rights so they decide how much pollution to produce. at the max level of pollution, the marginal benefit is very small to the company however there are very large marginal costs to the community. this incentivises the two parties to negotiate. the community will pay the producer some money in order to reduce their emissions. this will continue along as the marginal benefit of pollution is less then the marginal cost to the community

Question 20

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