Flashcards in Chapter 6: Positive externalities Deck (39):
When do positive externalities exist?
When the social benefit of a good or service is greater than the private benefit.
Give an example of when a private action benefits a third party.
When an individual uses deodorant, this obviously benefits themselves but their fragrant odour also has a benefit to others.
Give some examples of goods that exhibit positive externalities.
Health, education, the arts, sports, museums, pensions and libraries.
What is the social benefit equal to?
Private benefit + externality = social benefit
What area is represents the net welfare loss on a diagram for a merit good?
It is a triangle and its largest side is the distance between the MPB and the MSB.
Why is there a net welfare loss for merit goods?
This is something we could be getting but we are not.
What failure can government provision correct?
If the market system fails to provide an optimal level of goods which exhibit positive externalities i.e. merit goods.
How can the government use subsidies to produce more merit goods?
The effect of a subsidy is to reduce the costs of production and so the MPC curve shifts to the right because it entices firms to produce more than they might otherwise have done.
Give an example of legislation that encourages more use of merit goods.
Every child has to attend school.
How can the government use information to encourage more usage of merit goods?
The government could use advertising or any other form of communication to reduce the chances of consumers making ill-informed choices.
How can taxes be used to encourage more usage of merit goods?
Individuals could be offered tax relief.
What can the absence of competition lead to?
Both allocative and productive inefficiency may emerge.
What are the problems with government provision?
It leads to an absence of competition, government agencies may also be unresponsive to consumer preferences and administration may become bureaucratic (too caught up in following rules and procedures).
What is a cost-benefit analysis?
It is an attempt to capture and assess all of the costs and benefits associated with a project.
What are some positive externalities of construction?
Increased trade and employment.
What are some negative externalities of construction?
Loss of countryside, the noise imposed on people living near the construction site and the prospect of someone losing their life in the process of construction.
Why does the free market not always take into account external costs and benefits?
Decisions are made on the basis of private costs and private benefits alone.
When can a project be allowed to proceed?
If the total benefits to society outweigh the total costs.
List the five stages in a cost-benefit analysis?
1. Identify all the costs and benefits, 2. Attach a monetary value to each of the costs and benefits, 3. Work out the probability of each cost and benefit occurring, 4. Take some account of the time horizon involved, 5. Make a final decision on the basis of the final figures.
What happens in the first stage of a cost-benefit analysis?
It is necessary to identify all the social costs, private costs, social benefits and private benefits.
How can you calculate the monetary value of private costs?
This is the cost of all the factors of production used in the construction such as labour, capital and raw materials.
What is the private benefit to the company?
The expected revenues of the completed project.
Give an example of why monetary values of externalities are difficult to calculate.
It is hard to put a value on the loss of the beautiful countryside for instance.
How can past projects be used to estimate the value of an externality?
You can compare the property values before and after the completion of a large project that is similar to your project to estimate the cost of noise pollution for instance or the loss of the countryside.
How would opportunity costs be used to estimate the monetary gain of building a new road which relieved congestion?
You could multiply the number of hours lost owing to congestion and then multiply this by the average wage of the typical road user so that you can calculate the opportunity cost of congestion.
How can surveys be used to quantify the value of an external cost or benefit?
Surveys can ask people how much they would be willing to pay to preserve something or how much they would need in compensation for the loss of something.
What happens in stage three of a cost-benefit analysis?
The values of all the variables are multiplied by the probability of their occurrence.
Why is it important to take into account a time horizon?
The expected revenues and costs may change overtime.
When are some projects viable?
If a long enough time horizon is used.
What is another factor that has to be considered in a CBA in terms of the rate of return?
Another factor that has to be considered is the rate of return that might have been gained if the money for the project had simply been invested.
Why is it important when doing the rate of returns calculation to have some idea of future interest rates?
The future path of interest rates is very uncertain.
What is a way in which you can avoid the problem of interest rates changing in the future?
Doing a series of interest rate calculations based on different interest rate scenarios.
What else can have a bearing on the final decision based on a CBA?
Whether a project proceeds or not is determined by politicians so political factors also have an effect on the final decision.
Why is a CBA better than a private investment appraisal?
It takes some account of positive and negative externalities.
Why does a CBA take a long view and a wide view?
It assesses costs and benefits over a long period of time and it tries to capture social costs as well as private costs.
What is a limitation of using past projects to estimate monetary values?
The extent to which any two projects are similar will have some bearing on the usefulness of past projects.
What is the limitation of using opportunity costs to estimate monetary values?
It uses averages and averages mask inequalities.
What is the limitation of using surveys to estimate monetary values?
Sometimes people are confused or misunderstand the issues involved. Also, prompted by greed, people overestimate or exaggerate about how much they value external benefits in order to get more compensation.