Externalities

Question 1

What is the definition of an externality?

Answer 1

A person engages in an activity that influences the well-being of a bystander but neither pays nor receives compensation for that effect.

Question 2

What makes a negative externality?

Answer 2

If the effect on the bystander is adverse

Question 3

What makes a positive externality?

Answer 3

If the effect on a bystander is beneficial

Question 4

Why is a negative externality a market failure?

Answer 4

Society’s interest in a Markey outcome extends beyond the buyers and sellers, but the bystanders. The equilibrium is inefficient because it fails to maximize the total benefit to society as a whole.

Question 5

What is the social cost curve compared to the supply cost

Answer 5

Supply is the private cost to the producers.
Social cost is private cost + cost to bystanders. In the case of smoke pollution, the difference between the two is the cost of the smoke emitted.

Question 6

What does the demand curve reflect in an externalities graph

Answer 6

the value to buyers

Question 7

Why is there deadweight loss with a socially optimal equilibrium in a negative externality?

Answer 7

Between the social equilibrium and the market equilibrium, the marginal benefit to the consumer is outweighed by the social cost of the externality. The market produces too much to be socially desirable.

Question 8

What is an example of a positive externality?

Answer 8

The benefits to society of education, and therefore more productive workers or better voting and therefore better government, or lower crime rates

Question 9

Negative externalities lead markets to produce a … quantity than Is socially desirable.

Answer 9

Greater

Question 10

If the production of a good yields a negative externality, the social-cost curve lies … the supply curve, and the socially optimal quantity is … than the equilibrium quantity.

Answer 10

above; less

Question 11

In what way does the patent system help society solve an externality problem?

Answer 11

The patent system helps society solve the externality problem from technology spillovers. By giving inventors exclusive use of their inventions for a period of time, the inventor can capture much of the benefit of the invention. in doing so, the patent system encourages research and technological advance, which benefit society through spillover effects.

Question 12

List some of the ways that the problems caused by externalities can be solved without government intervention?

Answer 12

Externalities can be solved without government intervention through moral codes and social sanctions ( which tell us to internalize externalities), charities, merging firms whose externalities affect each other, or by contract/negotiation.

Question 13

How might you determine whether a roommate smokes in the room you share. Is it efficient? How will the solution be reached?

Answer 13

According to the Coase theorem, you and your roommate will bargain over whether your roommate will smoke in the room. If you value clean air more than your roommate values smoking, the bargaining process will lead to your roommate not smoking. But if your roommate value smoking more than you value clean air, the bargaining process will lead to your roommate smoking. The outcome is efficient as long as transaction costs do not prevent an agreement from taking place. The solution may be reached by one of you paying off the either not to smoke or for the right to smoke.

Question 14

Even if an externality is resolved using a private solution, what other issues or problems might stem from a situation? (Rights)

Answer 14

Coase theorem does not implicate the underlying allocation of property rights. An efficient outcome will emerge regardless of soft who the property rights are initially assigned to. However, it is better to have the property rights than not. Another issue that can affect who is better off includes who is better at bargaining (bargaining power), or if there is uncertain information about the others’ value, making it difficult to reach a bargain

Question 15

What are corrective taxes?

Answer 15

Taxes enacted to correct the effects of a negative externality

Question 16

What is another word for corrective taxes?

Answer 16

Pigouvian taxes (after an early advocate of their use)

Question 17

What is a command-and-control policy to resolve an externally?

Answer 17

Regulating the production of an externality directly (e.g pollution bans or limits)

Question 18

In what situation might a command-and-control policy for an externality be useful?

Answer 18

If the external costs to society far exceeds the benefits to the producer of the externality.

Question 19

What is internalizing the externality?

Answer 19

Altering incentives so that people take account of the external effects of their actions.

Question 20

Why do economists prefer corrective taxes over regulations as a way to protect the environment from pollution?

Answer 20

They can reduce pollution at a lower cost to society. A tax can be set to reduce pollution to the same level as a regulation. The tax has the advantage of letting the market determine the least expensive way to reduce pollution. The tax gives firms the incentive to develop cleaner technologies to reduce the taxes they have to pay.

Question 21

Between a steering wheel lock and a tracking system, which car protection has a negative externality and which has a positive externality? What policy implications derive from this?

Answer 21

The lock has a negative externality on other car owners because thieves will see the lock and switch cars to steal; the recovery system has a positive externality because thieves do not know which cars have this technology and are less likely to steal. The implication is a subsidy for recovery systems and a tax on locks.

Question 22

True or false. The benefits of corrective taxes as a way to reduce pollution have to be weighed against the deadweight losses that these taxes cause. Why?

Answer 22

False. Corrective taxes reduce the inefficiency pollution by reducing te quantity of the good being produced that has pollution as a by-product, so corrective taxes reduce deadweight loss instead of increasing it.

Question 23

True or false: When deciding whether to levy a corrective tax on consumers or producers, the government should be careful to levy the tax on the side of the market generating the externality.

Answer 23

False: it does not matter on whom the tax is imposed- the burden will be split in the same way, depending on the elasticity of supply or demand.

Question 24

Why might fire extinguishers exhibit positive externalities?

Answer 24

People buy them for their own use but they help limit the spread of fires and can prevent a fire from damaging the property of others.

Question 25

How would the externality form fire extinguishers be graphed?

Answer 25

An increase in the social value over the market value-- the demand curve

Question 26

Why do market and optimal equilibriums differ?

Answer 26

They do not account for the benefits or penalties provide to other people

Question 27

What policy might a government use to increase society's benefit from fire extinguishers?

Answer 27

A subsidy

Question 28

Ringo and Luciano are neighbours. Ringo loves playing rock and roll music; Luciano hates rock and roll. What is the externality?

Answer 28

Noise pollution. The noise affects Luciano but Ringo does not take that into account when playing it.

Question 29

How might a landlord try to regulate noise pollution from a noisy neighbour? Could it be inefficient?

Answer 29

Imposing a rule limiting the noise that music must be played at. It could be inefficient because there would be no harm done by the loud neighbour if the others are not home.

Question 30

How might the musical neighbours Ringo and Luciano reach an agreement&

Answer 30

Negotiation a time that might allow Ringo to play his music at certain times of day.

Question 31

Why might two negotiation parties fail to reach an agreement regarding externalities?

Answer 31

Transaction costs are high or if bargaining fails because each holds out for a better deal.

Question 32

The externality on other drivers from alcohol consumption affects what in a graph?

Answer 32

It affects the social value curve by pushing it downwards. The negative e externality from increased motor accidents is caused by consumers who drink and drive.

Question 33

If society wished to reduce overall pollution by a certain amount, why is it efficient to have different amounts of reduction at different firms?

Answer 33

Because the costs of reducing pollution differ across firms. If they were all made to reduce pollution by the same amount, the costs would be low at some firms and prohibitive at others, imposing a greater burden overall.

Question 34

Command-and-control approches to pollution often rely on uniform reductions among firms. Why are these approaches generally unable to target the firms that should undertake larger reductions?

Answer 34

These approaches give the firms no incentive to reduce pollution beyond the mandated amount. Instead, every firm will reduce pollution by just the amount required and no more.

Question 35

Economists argue that appropriate corrective taxes or traceable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should undertake larger reductions?

Answer 35

They give firms greater incentives to reduce pollution. Firms are rewarded by paying lower taxes or spending less on permits if they find methods to reduce pollution, so they have the incentive to engage in research on pollution control. The government does not have to figure out which firms can reduce pollution the most; it lets the market give firms the incentive to reduce pollution on their own.

Question 36

True or false; a corrective tax and pollution permits have identical effects.

Answer 36

True.

Question 37

Suppose that the government decides to issue tradable permits for a certain form of pollution. Does it matter for economic efficiency whether the government distributes or auctions the permits? Why or why not?

Answer 37

In terms of economic efficiency in the market for pollution, it does not matter, as long as firms can sell the permits to each other. The only difference would be that government can make money if it auctions them, and thereby reduce taxes, which would reduce the deadweight loss form taxation. There could also be some deadweight loss if firms use resources to lobby for additional permits.

Question 38

If the government chooses to distribute the permits, does the allocation of permits among firms matter for efficiency? Why?

Answer 38

If the government allocated the firms that did not highly value them as other firms, the firms could sell the permits to each other so that they would end up in the hands of the firms that value them most highly. Thus, the allocation of permits among firms would not matter for efficiency, but it would affect the distribution of wealth, since those who got the permits and sold them would be better off