Week 7 Flashcards
Define externality
An externality exists when market prices don’t take into account the marginal cost and benefits to all parties impacted by the transaction.
Some examples include pollution and education.
Marginal Social Cost
This is the total cost of the production of a product including the private Marginal Cost and the cost impact of externalities (MEC).
MSC = MC + MEC
Total Surplus
Total surplus is the sum of all things…
TS = CS + PS + EB - EC + GR - GE
What happens with a negative externality?
1) Output is too high
2) Costs are too low
3) There’s too much pollution
What is a pigouvian tax?
A pigouvian tax is a tax that attempts to raise the price of a good to compensate for the externality, internalizing the externality.
What are some ways to fix an externality?
1) Moral suasion (not great)
2) Tax or subsidy (price impacts)
3) Regulation
4) Property rights
What are market sellable permits, and what’s the benefits of them?
Market sellable permits is a way to limit, quantity-wise, the output of a market. Because it creates a secondary market for pollution (often), the MC of the ability to creation pollution directly relates to the benefit to the firm. Works well when it’s hard to identify how much the pollution costs. Hardest part is initial allocation.
If it’s difficult to estimate an appropriate regulation to manage an externality, how should you decide whether to tax the price or regulate the quantity?
Think about what will have the bigger societal impact if you’re wrong by a small margin. Typically this means if the demand curve is steeper, then you should tax and if the MC/supply curve is steeper, then you should tackle regulating output.
What is the Coase Theorem?
If we assume:
1) Property rights to all resources are well defined and enforced
2) There are no transaction costs
Then the allocation of resources will be efficient no matter who has the property rights.
Conversely, externalities only exist when property rights are not well defined or transaction fees are high.
If there are transactions costs, how does that impact property rights?
Assignment of property rights affect the relative efficiency (or social surplus) of the outcome. This is when you need to take into account the least cost avoider.
Who is the least cost avoider?
The least cost avoider is the person who can avoid the externality in the least costly way.
If there are transaction costs, who should the property rights be assigned to for the best social outcome?
Figure out who is the least cost avoider, and assign the rights to the other party.
