Externalities & Public Goods

Question 1

What is an externality?

Answer 1

An externality is the cost or benefit a third party receives from an
economic transaction outside of the market mechanism. ( SPILLOVER COSTS)

Question 2

What is a negative externality?

Answer 2

Negative externalities of production occur when social costs are greater than private costs

Question 3

What is a positive externality?

Answer 3

Positive externalities of consumption occur when social benefits are greater than social
costs.

Question 4

Is price change an externality?

Answer 4

No

Question 5

What is the marginal private cost?

Answer 5

The extra cost from one

extra unit paid by the seller

Question 6

What is the marginal external cost?

Answer 6

The extra external cost

from one extra unit

Question 7

Formula for. MSC

Answer 7

Marginal social cost = Marginal private cost +

Marginal external cost

Question 8

What is MPB?

Answer 8

The external benefit

from one extra unit enjoyed by the buyer

Question 9

What is an external benefit?

Answer 9

A benefit accruing to

bystanders.

Question 10

What is a marginal external benefit?

Answer 10

The extra external

benefit from one extra unit.

Question 11

MSB Formula

Answer 11

Marginal social benefit = Marginal private

benefit + Marginal external benefit

Question 12

What is an external cost?

Answer 12

A cost imposed on bystanders.

Question 13

What is the socially optimum output that is desirable to all parties?

Answer 13

Marginal social benefit = Marginal social cost

Question 14

What is the 3 step recipe when analysing externalities?

Answer 14

Step 1: Predict the equilibrium outcome to forecast
what you think will happen.
Step 2: Assess what externalities are involved.
Step 3: Figure out what outcome is in society’s
best interests, and then compare this to the
equilibrium forecast from the first step

Question 15

What are the 6 solutions to internalising an externality?

Answer 15

1. Private bargaining and the Coase Theorem
2. Fix the price: Corrective taxes and subsidies
3. Fix the quantity: Cap and trade
4. Laws, rules, and regulations
5. Government provision of public goods
6. Assign ownership rights

Question 16

What is the Coase Theorem?

Answer 16

Coase theorem: If bargaining is costless, property
rights are clearly established and enforced, and
externality problems can be solved by private
bargains

Question 17

What can private bargaining help restore?

Answer 17

Private bargaining can restore the socially optimal

outcome.

Question 18

2 types of private bargaining?

Answer 18

Mergers and strategic investments

Question 19

What is a corrective tax?

Answer 19

A tax designed to induce people to take

account of the negative externalities they cause. Solves negative externalities

Question 20

What do corrective subsidies fix?

Answer 20

Corrective subsidies can fix

positive externalities.

Question 21

What is cap & trade?

Answer 21

Cap and trade: A quantity regulation implemented
by allocating a fixed number of permits, which can
then be traded.

Question 22

A cap and trade system is like a ….

Answer 22

A cap-and-trade system is like a corrective tax.

Question 23

What is a quota?

Answer 23

A limit on the maximum quantity of a good

or service that can be sold

Question 24

Corrective taxes, subsidies and cap & trade attempt to all do what ….

Answer 24

Both corrective taxes or subsidies and cap-and-trade
systems attempt to harness the power of the market to
solve externality problems as efficiently as possibl

Question 25

What are the 2 characteristics of public goods?

Answer 25

They are non-rivalry, which means that one person’s use of the good doesn’t stop someone else from using it They are also non-excludable, meaning that you cannot stop someone from accessing the good and someone cannot chose not to access the good.

Question 26

What is the free rider problem?

Answer 26

A situation that arises when someone can enjoy the benefits of a good without bearing the costs

Question 27

What is a rival good?

Answer 27

A good for which your use of it comes | at someone else’s expense

Question 28

What is a solution for a public good?

Answer 28

Club good: A good that is excludable but non-rival in | consumption. Example: cable TV

Question 29

What is a common resource?

Answer 29

A good that is rival and also | non-excludable.

Question 30

What is the tragedy of the commons?

Answer 30

The tragedy of the commons occurs whenever rival goods are non-excludable.

Question 31

How can you solve the tragedy of the commons?

Answer 31

Assign ownership rights to solve the tragedy of the | commons.