2.2 Externalities

Question 1

positive consumption externality

Answer 1

MSB = MPB + MEB
=> MSB > MPB

Question 2

negative consumption externality

Answer 2

MSB = MPB + MEC
=> MSB < MPB

Question 3

positive production externality

Answer 3

MSC = MPC + MEB
=> MSC < MPC

Question 4

negative production externality

Answer 4

MSC = MPC + MEC
=> MSC > MPC

Question 5

what is a negative production externality

Answer 5

when the production of a good/service has a negative impact on a third party not involved in producing or consuming the good

Question 6

is externality market failure?

Answer 6

an externality is not market failure in itself; but it can cause market failure when ignored by market decision makers

Question 7

examples of negative production externalities

Answer 7

• pollution from factory causing health problems for local residents
• traffic congestion caused by the rebuilding of a road
• resource depletion/ degradation
• deforestation

Question 8

what is a positive production externality

Answer 8

when the production of a good/service has a positive impact on a third party not involved in the producing or consuming of the good

Question 9

examples of positive production externalities

Answer 9

• increase employment and economic growth
• biodynamic farming promotes biodiversity and a habitat for pollinators
• the production of manneure from livestock fertilizes soil

Question 10

what is a negative consumption externality

Answer 10

when the consumption of a good/service has a negative impact on a third party not involved the producing or consuming of the good

Question 11

examples of negative consumption externalities

Answer 11

• smokers
• fireworks
• alcohol
• fossil fuel-consuming vehicles

Question 12

what is a positive consumption externality

Answer 12

when the consumption of a good/service has a positive impact on a third party not involved in the production or consumption of the good

Question 13

examples of positive consumption externalities

Answer 13

• vaccines (preventative healthcare)
• sustainable forms of transport
• deodorant
• renewable energy
• education

Question 14

source of market failure

Answer 14

decisions are based on private costs/benefits but welafre is maxmised when the full social costs/benefits are considered

Question 15

Explaining externalities with a diagram

Answer 15

(1) say whether social cost/benefit is greater than private
(2) explain the private side
(3) explain the social side
(4) say why its the socially ptimum point (MSB = MSC)
(5) say what form of market failure is happenign

Question 16

policies to correct market failure caused by negative externalities

Answer 16

• indirect taxes
• carbon taxes
• tradeable pollution permits/caps
• government regulations
• information campaigns

Question 17

indirect taxes to correct negative production externalities

Answer 17

1) gov’t sets tax = per unit externality, S curve shifts inwards to S(MPC+tax) creating a new equilibrium at q.so. (qtax)
2) the market operates @ the s.o. level of output => welfare loss is eliminated
3) price increases from Pm to Ptax - higher price now refelect the full cost of the good
4) gov’t gains tax revenue

Question 18

indirect taxes to correct negative consumption externalities

Answer 18

1) tax is used to shift the supply curve inwards so that it intersect with D(MPB) at Qs.o.
2) the market operates at the s.o. levle of output => welfare loss is eliminated
3) price increases so that the higher price now reflects the full cost of the good
4) gov’t gains tax revenue

Question 19

evaluation of using indirect taxes to correct negative externalities

Answer 19

• the effectiveness depends on how easily measureable the externality is
• the effectiveness of the tax depends on the magnitude of the tax in relation to the externality
• the incidence of the tax depends on elasticity
• they are regrefessive
• poorly targeted

Question 20

why are indirect taxes poorly targeted

Answer 20

because the taxes are not focused on the consumers or producers that are engaged in the harmful behaviour, so they don’t offer an incentive to change the behaviour

Question 21

incidence of the tax

Answer 21

PED elastic => firms pay
PED inelastic => consumers pay

Question 22

negative externality that carbon taxes aim to correct

Answer 22

global warming:
- increased risk of natural disaster
- risks to good security/famine
- costs of mirgation as people escape inhospitable environments

Question 23

how do carbon taxes work

Answer 23

(1) they raise business costs for firms, causing them to internalize the externality and shift supply to the left
(2) they create an incentive for firms to swtich to green energy

Question 24

pros of carbon taxes

Answer 24

• enoucrage firms to switch to green energy
• increases the s.o. optimum quantity of output
• easier to implement/design
• can be applied to all fossil fuel using industries
• does not require as much monitoring or enforcement
• makes energy prices more predictable

Question 25

cons of carbon taxes

Answer 25

- taxes face political pressures t be set too low - cannot target a particular level of carbon reducation - are regressive

Question 26

market for permits

Answer 26

- the supply of permits is perfectly inelastic because there is a fixed supply of permits - the price of the permits is determined by demand

Question 27

how do tradeable permits address the externality problem?

Answer 27

(1) immediately reduces the amount of carbon (externality) produced and raises costs for firms (2) incentive impact

Question 28

types of gov't regulations to prevent negative externalities

Answer 28

- ban on gum chewing in singapore - bans on smoking in public places - policies requiring consumers to pay for waste dispsoable bags - regulations on chemical affluents - regulations on diesel cars - quantity restrictions on certain purchases - age restrictions - gun laws

Question 29

evaluation of regulation

Answer 29

- fixing the appropriate level of regulation - the costs to firms of emeting the regulations - impact on international competitiveness

Question 30

examples of tradeable permit schemes

Answer 30

european union emissions trading sysetms (2005) - never been high enough to be effective

Question 31

another word for trabale permits

Answer 31

emissions trading system (ETS)

Question 32

limitations of tradable permits

Answer 32

- political favorutism - research and technical info required to set up - if cap set too low, firms struggle to produce - makes prices unpredictable - often only targets on industry/small group

Question 33

policies to correct market failure due to positive externalities or merit goods

Answer 33

- subsidies - direct provision - legislation/regualtion - information campaigns -nudges

Question 34

limitations of subsidies

Answer 34

- effect depends on PED - difficult to estimate externality - danger firms may become to reliant on subsidies - opportunity cost to gov't budget

Question 35

limitations of government regulation

Answer 35

- can often over-correct (e.g. bans) - don't tackle the root problem

Question 36

pros of gov't regulation

Answer 36

- can target certain areas - do not rely on changes in consumer behaviour

Question 37

subsidies to correct market failure due to positive consumption externalities

Answer 37

- aim to set the per unit subsidy equal to the per unit externality so that supply shifts out and intersects demand at qso.o - subsidy lowers price from Pm to psubs and increases quantity sold (correcting the welfare loss) - both producer and consuer surplus increases - cost to the gov't of per unti subsidy x quantity sold

Question 38

direct provision to correct amrket faillure due to positive consumption externalities

Answer 38

- gov't supplements market supply with its own provision - price down and quantity sold increases

Question 39

examples of direct provision to correct market failure due to positive consumption externalities

Answer 39

- public education - contraception - vaccinations

Question 40

example of government regulation to correct market failure due to cosumption externalities

Answer 40

- schools require SexEd for students - education currciulums - masks compulsory - eduation laws - car insurance required - vaccine passports in korean -washing your hands campaigns