Externalities

Question 1

How do supply and demand curves not show externalities?

Answer 1

• only private costs and benefits are included
• affected bystanders cost / benefits is not seen
• total surplus maximised (efficient)

Question 2

What is the supply curve equal to? (externalities)

Answer 2

Private marginal cost (PMC)

Question 3

What is the demand curve equal to? (externalities)

Answer 3

Private marginal benefit (PMB, based on utility)

Question 4

What happens to S/D with externalities?

Answer 4

There is a dead weight loss (harm to the bystander)
Corrective taxes and subsidies aim to eliminate this at the equilibrium

Question 5

What is an Externality?

Answer 5

An externality is a spillover cost or benefit to a third party, that is not part of the original transaction

Question 6

What is not considered an externality?

Answer 6

They have already been compensated for the occurrence
- if there is a lower price due to a negative occurrence, it is not an externality

Question 7

What is SMC?

Answer 7

Social Marginal Cost

Question 8

What is SMB?

Answer 8

Social Marginal Benefit

Question 9

What happens with a negative externality of production?

Answer 9

-SMC is higher than PMC/S
-Qp is too high

Question 10

How do we see an externality of a S/D graph?

Answer 10

Distance between the original curve and new SMB / SMC

Question 11

What happens with a positive externality of production?

Answer 11

• SMC smaller than PMC/ S
• Qp is too low

Question 12

How do you calculate SMC for a negative externality of production?

Answer 12

SMC = PMC + Negative Externality

Question 13

How do you calculate SMC for a positive externality of production?

Answer 13

SMC = PMC - offsetting benefit of production

Question 14

What happens with a negative externality of consumption?

Answer 14

• SMB smaller than PMB/D
• Qp is too high

Question 15

What happens with a positive externality of consumption?

Answer 15

• SMB greater than PMB / D
• Qp is too low

Question 16

How do you calculate SMB for a positive externality of consumption ?

Answer 16

SMB = PMB + Externality (additional benefit)

Question 17

How do you calculate SMB for a negative externality of consumption?

Answer 17

SMB = PMB - Externality (additional cost)

Question 18

Define Negative externality of Consumption

Answer 18

There is an offsetting cost to society arising from consumption of the good, that private consumers do not account for
- Society does not value the good as highly as the private individual does
SMB lies below PMB once the external cost is counted for

Question 19

Define Negative externality of Production

Answer 19

True cost to society (cost of production + externality) is greater than the private cost (cost of production)

SMC lies above PMC

Question 20

Define Positive Externality of Production

Answer 20

There is some offsetting benefit to society arising from the production of honey, that producers do not account for
- SMC lies below PMB once this benefit has been accounted for

Question 21

Define Positive externality of Consumption

Answer 21

The true benefits to society are greater than the benefits to the individual
- SMB is above PMB

Question 22

What is Coase’s Theorem?

Answer 22

This theorem states that if property rights are assigned appropriately (the role of government), private parties can negotiate solutions to the problem of externalities

Question 23

What is needed for the Coase Theorem to work well?

Answer 23

• Property rights have to be well defined and enforceable
• Transaction costs have to be low (negotiating costs)

Question 24

What determines who pays compensation (Coase Theorem)

Answer 24

Who has the property right

Question 25

What is Qp

Answer 25

Qp (private quantity) is where PMC = PMB

Question 26

What is Qs?

Answer 26

QS (social quantity) is where SMB = SMC At Qs, all costs, including externalities have been accounted for, and all benefits have been captured, including externalities

Question 26

How can Supply / PMC be equal to SMC

Answer 26

If supply / PMC are not affected by the externality they become SMC (same from demand / PMB and SMB)

Question 26

What is a problem with the externality curves?

Answer 26

They are linear - this may not always be the case

Question 27

What are corrective taxes and subsides for?

Answer 27

removing dead weight loss (from the shift from Qp to Qs)

Question 28

What do taxes on negative externalities do?

Answer 28

Internalises the externality - imposes the cost on the producers and consumers who enjoy the private benefit, but generate the negative externality - Reduces quantity from Qp to Qs (removing DWL)

Question 29

What is the S+Tax curve identical to?

Answer 29

The SMC curve Externality is the same size as the tax

Question 30

How does the decrease in surplus interact with decrease in negative externality (tax)

Answer 30

- The decrease in negative externality is greater than the decreased surplus (1) Lost negative externality not offset by lost surplus (Area 1 lost surplus cancels out the area 1 lost negative externality) (Area 2 is an improvement in efficiency resulting from the tax.)

Question 31

Why don't reduce quantity past QS?

Answer 31

Because the area of lost surplus would be greater than the area of lost negative externality - Qs is the efficient quantity

Question 32

Where is a subsidy shown?

Answer 32

On the supply side (even if its an externality in consumption) (money goes to the uni rather than each student)

Question 33

What is the size of subsidy equal to?

Answer 33

The size of the subsidy (difference between S/SMC and S+Sub) is the same as the size of the externality (difference between D and SMB)

Question 34

What is the relationship between the gain and cost of subsidy?

Answer 34

The gain outweighs the cost of the subsidy

Question 35

What may happen if an externality is very large?

Answer 35

banning the good may be more effective than a tax. Government banning drugs, or making vaccines free and compulsory, is an example of government regulation.