CHAPTER 21: EXTERNALITIES IN COMPETITIVE MARKETS

Question 1

What is a positive consumption externality

Answer 1

When the social benefit of consuming a good is greater than the private benefit

Question 2

How do competitive markets behave in the presence of a positive consumption externality

Answer 2

They underproduce the good compared to the efficient level

Question 3

What is the efficient output level under a positive consumption externality

Answer 3

The level where social marginal benefit (SMB) equals supply, labelled xb

Question 4

What is the market output level under a positive consumption externality

Answer 4

The level where private demand equals supply, labelled xm

Question 5

What causes DWL in this context

Answer 5

Underproduction of the good xm < xb due to the externality

Question 6

What is the dwl, the extra surplus that is

Answer 6

Possible but not realised

Question 7

Total surplus with market production

Answer 7

A+b+c

Question 8

Max possible total surplus

Answer 8

A+b+c+d

Question 9

What is a pigouvian subsidy

Answer 9

A per-unit subsidy equal to the difference betweeen a social and private marginal benefit at the efficient output

Question 10

What is the goal of a pigouvian subsidy

Answer 10

To increase market output to the efficient level xb

Question 11

What problem does a pigouvian subsidy fix

Answer 11

Eliminated dwl from underproduction due to a positive externality

Question 12

How does pigouvian subsidy affect market quantity

Answer 12

Raises it front the market level xm to the efficient level xb

Question 13

Why does pollution create an externality

Answer 13

Firms use inputs like clean air without paying for them - no market pricing that input

Question 14

Why do positive externalities occur

Answer 14

Because a “product” (like a social benefit) is created but there’s no market to charge for this consumption

Question 15

What is the core cause of externalities

Answer 15

The non-existence of markets to price certain inputs or outputs

Question 16

How could externalities by solved in theory

Answer 16

By assigning property rights and allowing competitive trade in those rights.

Question 17

Why isn’t assigning property rights always a solution in practice

Answer 17

Because its often impractical or too costly to implement

Question 18

What causes the tragedy of the commons

Answer 18

Resources are free for anyone to use because no property rights are assigned

Question 19

What type of problem does common ownership create?

Answer 19

A missing market problem due to lack of property rights

Question 20

What happened when proposers rights can’t be assignmed

Answer 20

Governments may use policies to improve efficiency

Question 21

What is a key role fo government in preventing overuse of resources

Answer 21

Establishing and protecting property rights to take resources “out of commons”

Question 22

What does the first welfare theorem state

Answer 22

Competitive markets efficiently maximise total surplus under certain conditions

Question 23

How is surplus maximised for a normal good in competitive markers

Answer 23

Surplus is maximises where supply meets demand, even with different individual MWTP curves

Question 24

What is a subtle limitation of the output level chosen by the market

Answer 24

It it optional only given the existing income distribution

Question 25

What causes market inefficiency in the context of externalities

Answer 25

Externalitities impose costs or benefits on others that market participants ignore

Question 26

When do private costs and benefits equal social costs and benefits

Answer 26

When there are no extrernalities

Question 27

How do externalities affect social costs and benefits compared to supply and demand curves

Answer 27

Social costs and benefits differ from those shown by supply and demand

Question 28

Why do competitive markets become inefficient with externalities

Answer 28

Because private and social incentives are not aligned

Question 29

What can help align private and social incentives to fix inefficiency

Answer 29

Actions by government, markets or civil society

Question 30

What is positive externality

Answer 30

An effect that improves the wellbeing of others (e.g. education, immunisation)

Question 31

What is a negative externality?

Answer 31

An effect that Harms the wellbeing of others (e.g. pollution, overfishing)

Question 32

Why does the market produce more than the socially optimal output in the case of negative externality?

Answer 32

Because the supply curve ignores the full social cost, like pollution

Question 33

What is DWL in the context of negative externalities

Answer 33

The loss of total social surplus due to overproduction and unaccounted social costs

Question 34

What is the difference between the market output and socially optimal output in pollution cases?

Answer 34

Market output (xm) is higher than socially optimal output (xb)

Question 35

What is corrective tax

Answer 35

A tax to fix negative externalities (pivgovian tax)

Question 36

What is corrective subsidy

Answer 36

A subsidy to fix positive externalities (pigouvian subsidy)

Question 37

What is pigouvian tax

Answer 37

A per unit tax equal to the extra social cost of a negative externality

Question 38

What effect does a pigouvian tax have on a market output

Answer 38

It reduces output to the efficient, socially optimal level

Question 39

What does pigouvian tax eliminate

Answer 39

The dwl causes by the externality