Externalities

Question 1

What is a externality?

Answer 1

1. Welfare of one agent is directly affected by the actions a second agent
2. There is no market to evaluate this effect and reward or penalise against the second agent accordingly

Question 1

Why do competitive firms create excessive amounts of negative externalities?

Answer 1

Because they do not have to pay for the harm done

Question 2

Why do producers and individuals only produce small positive externalities?

Answer 2

Because they are not compensated for it

Question 3

What is the primary result of externalities?

Answer 3

Non-optimal production and consumption

Question 4

What does the marginal external cost show?

Answer 4

The marginal external cost (MEC) measures the damage to the enviroment caused by the production of an additional unit of good

Question 5

What does the marginal private cost show?

Answer 5

The private cost of producing an additional units of good

Question 6

What does the marginal social cost show and how can it be found?

Answer 6

The sum of the private marginal cost curve and marginal external cost of pollution MSC= MPC + MEC

Question 7

Where can the optimal point be found when assessing the demand curve with respect to marginal social costs and marginal private costs?

Answer 7

The optimal point is where the firm treats the social cost as its own cost function this minimises the dead weight loss

Question 8

Why is a social optimum not achieved at a competitive equilibrium?

Answer 8

Because the prices too low and demand is too high, relative social optimum

Question 9

What is the reason for the social optimum not being equal to the marginal private cost?

Answer 9

Cost of pollution is ignored in consumption and production. We say, producers, do not internalise the externality on consumers.

Question 10

What is the marginal external benefit?

Answer 10

The benefit to the enviroment (other people) from the consumption of each additional unit of good

Question 11

What is the marginal social benefit?

Answer 11

The sum of the marginal private benefit and the marginal external benefit

Question 12

What is the marginal private benefit the same as?

Answer 12

The inverse demand curve

Question 13

Under the positive consumption externalities model, where is the competitive equilibrium?

Answer 13

Where MC (q) = MPB (q)

Question 14

Under the positive consumption externalities model, where is the socially optimal outcome?

Answer 14

Where MC(q^s) = MSB (q^s)

Question 15

Does the firm produce too much or too little at the competitive equilibrium under positive consumption externalities?

Answer 15

In competitive equilbrium, the price is too high and demand too low relative to the socially optimal point

Question 16

What is a common remedy to externality problems?

Answer 16

A common solution is a Pigou tax or a subsidy

Question 17

How would a subsidy work under a positive consumption externalities model?

Answer 17

To reach the social optimum open, expand, supposedly government wants to pay consumers a subsidy s = p^s - p^d, where p^d is the MPB at qs

Question 18

What is the location of the contract curve dependent on?

Answer 18

The location of the contract curve depends on the trading mechanism and the legal system

Question 19

Why do problems often arise in the trading model?

Answer 19

Because property rights are sometimes poorly defined because it means that they will never negotiate

Question 20

What is the Coase theorem?

Answer 20

With property rights that are well defined and low transaction costs, parties involved can resolve externalities themselves through private negotiations

Question 21

How can we solve externality problems?

Answer 21

1. Subsidies/ taxes
2. Pollution permits
3. Emission Standards
4. Mergers
5. Property right allocation and bargaining

STEMPP

Question 22

What is a Pigouvian tax equal to?

Answer 22

The external cost associated with the economic activity

Question 23

What is a property right?

Answer 23

An exclusive privilege to use an asset

Question 24

What are some criticisms of Coase theorem?

Answer 24

Transaction costs information, a symmetry bargaining, power, enforceability

Question 25

If a good is rival and non-excludable, what is the name of it?

Answer 25

Common good

Question 26

If a good is non-rival and non-excludable, what is the name of it?

Answer 26

Public good

Question 27

If a good is non-rival but excludable, what is the name of it?

Answer 27

Club good

Question 28

If a good is rival and excludable, what is the name of it?

Answer 28

Private good

Question 29

How can free-riding be reduced?

Answer 29

1. Firms can merge to internalise the positive externality
2. Privatisation
3. Compulsion to avoid free-riding may come in the form of contracts and taxes