chapter 14
A negative externality causes:
A negative externality causes the social cost of production to be greater than the private cost. Social costs are the full cost to society due to the use of a resource. For example, a heavy manufacturing process costs in terms of labour and raw materials, but also in lower air and water quality costs that are borne by third parties. Social costs include all those costs which, in the case of a polluting industry, exceed the private costs. Additional Learning An externality occurs when someone other than the immediate parties to a transaction bear a portion of the cost or receive some benefit.
A situation in which one side of an economic relationship takes undesirable or costly actions that the other side of the relationship cannot observe is called:
A situation in which one side of an economic relationship takes undesirable or costly actions that the other side of the relationship cannot observe is called moral hazard. A moral hazard occurs when one party to a contract alters their behaviour as a result, and therefore, passes more risk to the other party. For example, a person might be more careless while driving after they purchase car insurance since they no longer bear as much risk. Asymmetric information is a situation where all the market participants do not have access to the same information. Asymmetric information can result in adverse selection which means the only goods left in the market are the undesirable goods.
An electric power producer generates an external cost by emitting high levels of pollutants when it uses coal to generate power. The presence of this externality leads to:
An electric power producer generates an external cost by emitting high levels of pollutants when it uses coal to generate power. The presence of this externality leads to overproduction. Since the power producer does not bear the cost of the pollution, it is not factored into the production decision and results in more power generation than would occur if the power company bore the costs. A positive externality would result in underproduction and economic efficiency would occur if there were no externalities.
What is an external benefit?
An external benefit is a benefit from a good experienced by someone other than the person who buys the good. External benefits can be provided by goods like a public park constructed near your home. While you did not pay for the park and were not involved in the transaction, you still benefit from being able to use the facilities. In addition, the new park might increase the value of your home. Additional Learning Private goods can also provide external benefits.
As the chance of getting a low-quality goods increases, buyers are willing to pay __________ for a used car and the quantity of high-quality cars will tend to __________.
As the chance of getting a low-quality goods increases, buyers are willing to pay less for a used car and the quantity of high-quality cars will tend to fall, resulting in a so-called thin market. This problem is called adverse selection. Sellers might not fully disclose all the car's defects in order to receive a higher price. Buyers do not have access to the same information which puts them at a disadvantage so buyers are unwilling to pay for the higher quality since they cannot detect it. Over time, only low-quality cars will remain in this market since the higher-quality cars will not bring the desired premium. A market where a smaller number of high-quality goods is sold than would be sold with perfect information is known as a thin market.
Asymmetric information means that:
Asymmetric information means that either buyers or sellers have better information than the other in a given market. Markets are not as efficient when all participants do not have access to the same information. When buyers and sellers have the same information, then it is by definition not asymmetric information. One of the reasons for the existence of asymmetric information is that buyers or sellers may hide information from one another.
What types of goods provide external benefits?
Both public goods and private goods provide external benefits. Public goods are those goods available for everyone to consume regardless of who is paying or not. Police protection is an example of a public good that you can see provides external benefits to anyone in a particular region even if their tax dollars do not pay for it. Private goods are goods that can be consumed by a single person or household. Education is an example of a private good that provides external benefits to society at large. A better educated citizen earns more money, pays more taxes, and is less likely to need government assistance.
Costs that are only borne by the individuals that incur those costs are known as:
Costs that are only borne by the individuals that incur those costs are known as private costs. These costs are also called internal costs because they only involve the parties involved in the transaction. When transactions only involve private costs and benefits, there are no externalities. Social costs are the full costs to society that occur when a resource is used that includes both internal and external costs.
Which of the following industries is most likely to result in a positive externality, and therefore, be subsidized?
Education is most likely to result in a positive externality, and therefore, be subsidized. Educated citizens are more likely to have higher paying jobs throughout their lifetime and therefore are less likely to need government assistance and more likely to pay higher taxes. The other industries, listed in the answer choices, are more likely to lead to pollution which would represent a negative externality.
Government is more likely to approve inefficient projects when
Government is more likely to approve inefficient projects when a few people share the benefit from a project and a large number of people share the cost. This is the outcome of decisions when a special interest group manipulates the government at the expense of a larger group (taxpayers). Since the cost to any one taxpayer is minor and not worth vocal opposition, it is common for this type of inefficient project to be approved. When the costs are high to a small group, they are much more likely to be vocally opposed and stall inefficient legislation that will be costly to them.
In some cases, the full cost of production is borne by someone other than the producer and the consumer. This will result in:
In some cases, the full cost of production is borne by someone other than the producer and the consumer. This will result in overproduction at a lower price when compared to the social efficient outcome. Since someone else is bearing some of the costs, the producers will continue to produce more units until the marginal costs they bear are equal to the marginal benefits they receive. This will result in the commitment of too many economic resources to the production of this product. Additional Learning Pollution is a cost borne by third parties.
Markets are said to be efficient if the price of the asset:
Markets are said to be efficient if the price of the asset reflects all information relevant to the value of that asset. In other words, asymmetric information does not exist. Financial markets have been shown to be efficient in Canada which helps to provide confidence in the system. In most cases, the markets determine the price, not the seller. And volatility has nothing to do with efficiency unless the volatility is due to the price reacting to the release of new relevant information.
Markets with unequal access to information between buyers and sellers can lead to a situation where only low-quality goods dominate in a given market. This is known as:
Markets with unequal access to information between buyers and sellers can lead to a situation where only low-quality goods dominate in a given market. This is known as adverse selection. If buyers cannot distinguish between a low-quality good and a high-quality good, the tendency will be for only low-quality goods to remain in the market over time since buyers will be unwilling to pay higher prices for higher-quality that cannot be easily determined until after the purchase. A situation in which one side of an economic relationship takes undesirable or costly actions that the other side of the relationship cannot observe is called moral hazard. A moral hazard occurs when one party to a contract alters their behaviour as a result, and therefore passes more risk to the other party. For example, a person might be more careless while driving after they purchase car insurance since they no longer bear as much risk. Asymmetric information is a situation where all the market participants do not have access to the same information. Asymmetric information can result in adverse selection.
Private goods are
Private goods are rival and excludable. Private goods are rival in consumption meaning only one person can consume the good. They are also excludable since it is possible to exclude someone from consuming the good if they did not pay for it. Additional Learning Candy bars, cars, and shirts are all examples of private goods.
Which of the following represents a possible solution to the tragedy of the commons
Privatizing the common property is a possible solution to the tragedy of the commons. When the common property is transferred to private property, the individual ownership will ensure the property is taken care of properly. The new owner may limit the use by quotas or charge an admission price sufficient to limit the number of people using the resource. Signs have limited impact on behaviour unless penalties are attached and constant monitoring occurs.
Which of the following represents a possible solution to the tragedy of the commons?
Privatizing the common property is a possible solution to the tragedy of the commons. When the common property is transferred to private property, the individual ownership will ensure the property is taken care of properly. The new owner may limit the use by quotas or charge an admission price sufficient to limit the number of people using the resource. Signs have limited impact on behaviour unless penalties are attached and constant monitoring occurs.
Social benefit is the total benefit from the consumption of a good or service that includes:
Social benefit is the total benefit from the consumption of a good or service that includes both private and external benefits. Social benefits include the private benefits that accrue to the parties involved in a transaction but also the benefits to society overall, the external benefits. For example, one external benefit to your college education is the additional taxes you will pay over your lifetime to support public goods.
Suppose the value that Nina places on a university education is $45,000 and the market price is $70,000. If the external benefit associated with Nina's attending university is $30,000, how large a subsidy would be required to get Nina to go to university?
Suppose the value that Nina places on a university education is $45,000 and the market price is $70,000. If the external benefit associated with Nina's attending university is $30,000, it would take a $25,000 subsidy to get Nina to go to university. The subsidy only has to cover Nina's shortfall of $25,000. The external benefit only matters to the government. If the subsidy costs less than the value of the external benefit, then it is a positive value investment for the government. Additional Learning This is largely why the government subsidizes education. It is a positive NPV investment.
Back in the days before inexpensive wristwatches and cellphones, most people did not carry an item that kept the time. Many towns built clock towers to help their citizens keep track of time. The towns paid for the towers with voluntary contributions from citizens. The clock tower suffered from the free-rider problem because the use of the tower was:
The clock tower suffered from the free-rider problem because the use of the tower was nonexcludable and nonrival. Public goods are nonexcludable since a public good is available for everyone to utilize, regardless of who pays for it and who does not. A public good is also nonrival in consumption meaning that a single person consuming a good does not prevent others from doing so. A free rider is someone who consumes a good without paying for it, so in this case there were countless free riders using the clock tower to tell time.
The government encourages people to become educated
The government encourages people to become educated because education generates external benefits. The external benefits include the existence of a skilled workforce for employers, higher wages that lead to fewer government transfer payments, and educated workers tend to make more money, and therefore, pay more in taxes. The investment made by the government to encourage education (cost) is less than the benefits produced for society overall (benefits). Education is considered to be rival in consumption since most of the benefits from education go to the one person consuming the education.
The idea of a pollution tax is to internalize the externality, which happens when the tax:
The idea of a pollution tax is to internalize the externality, which happens when the tax equals the external cost. The tax shifts the cost back to the producer and consumer and away from the third parties currently bearing the cost. A tax that is lower than the external costs does not internalize all of the costs. And, a tax greater than the external cost reduces output even further and could result in an external benefit.
The lack of clearly assigned __________ contributes to __________ of common resources.
The lack of clearly assigned property rights contributes to overuse of common resources. When no one clearly owns a resource, some individuals tend to gain far more benefit from use than it costs them individually. Society at large bears the remainder of the external costs. When enough individuals behave in this manner, it leads to overuse of common resources. Additional Learning For example, if someone cuts a tree for firewood on public land they gain a lot of benefit while the cost is spread over many other persons.
The lack of private ownership of certain resources like public lands or water can contribute to overuse. This is known as
The lack of private ownership of certain resources like public lands or water can contribute to overuse. This is known as the tragedy of the commons. Overuse occurs when the individual marginal benefit from some activity involving a common resource exceeds the individual marginal cost. The other phrases are fictitious, and therefore, meaningless.
The lack of private ownership of certain resources like public lands or water can contribute to overuse. This is known as:
The lack of private ownership of certain resources like public lands or water can contribute to overuse. This is known as the tragedy of the commons. Overuse occurs when the individual marginal benefit from some activity involving a common resource exceeds the individual marginal cost. The other phrases are fictitious, and therefore, meaningless.
Which of these is the preferred method to reduce the external cost (pollution) of traffic congestion according to an economist?
The preferred method to reduce the external cost (pollution) of traffic congestion according to an economist would be to levy a tax that varies with the level of congestion. The tax would internalize the cost of traffic congestion and lessen or remove the burden on third parties. Drivers would be taxed according to the number of miles they drive during peak congestion times. This tax would incentivize some drivers to identify other means of transportation (i.e., carpool, take public transportation, bike, etc.). The other two means are too costly to police and not as efficient.
The tendency for common resources to be overused is known as
The tendency for common resources to be overused is known as the tragedy of the commons. When common property is available for everyone to use with no restraints, there is an individual incentive to overuse the resource even though there are external costs being borne by others. When enough people behave in this manner, it can destroy the resource. Additional Learning The word commons stems from the common ground used to graze sheep and cattle during the Middle Ages. Since no one owned the property, there was a tendency to allow continued grazing of your livestock without restraint until the commons were devoid of grass.
The tendency for common resources to be overused is known as:
The tendency for common resources to be overused is known as the tragedy of the commons. When common property is available for everyone to use with no restraints, there is an individual incentive to overuse the resource even though there are external costs being borne by others. When enough people behave in this manner, it can destroy the resource. Additional Learning The word commons stems from the common ground used to graze sheep and cattle during the Middle Ages. Since no one owned the property, there was a tendency to allow continued grazing of your livestock without restraint until the commons were devoid of grass.
When either too few or too many economic resources are flowing to a specific economic activity it is known as
When either too few or too many economic resources are flowing to a specific economic activity, it is known as market failure. In some situations, a third party to a transaction bears some of the cost and creates a suboptimal solution. For example, a heavy manufacturing facility may be polluting the river and the downstream population is bearing this cost. This is one example of a market failure. Government intervention is necessary in this type of market failure. Markets are efficient when they reach a point where marginal benefits equal marginal costs and the total surplus is at the highest level. An externality is a consequence of some economic activity that impacts a third party that is not involved in the original transaction.
When either too few or too many economic resources are flowing to a specific economic activity it is known as:
When either too few or too many economic resources are flowing to a specific economic activity, it is known as market failure. In some situations, a third party to a transaction bears some of the cost and creates a suboptimal solution. For example, a heavy manufacturing facility may be polluting the river and the downstream population is bearing this cost. This is one example of a market failure. Government intervention is necessary in this type of market failure. Markets are efficient when they reach a point where marginal benefits equal marginal costs and the total surplus is at the highest level. An externality is a consequence of some economic activity that impacts a third party that is not involved in the original transaction.
When no one owns a specific resource, there is:
When no one owns a specific resource, there is not enough incentive to consider negative externalities that impact that resource. The existence of property rights are at the source of the externality problem. For example, since no one owns the air, and the impact of one individual is minimal, there is no real reason to not pollute if it increases a person's marginal benefit. However, if all behave that way then the issue is magnified. Negative externalities are most often associated with resources that do not have defined private property rights.
When we talk about property rights in the discussion of externalities, which rights do we refer to?
When we talk about property rights in the discussion of externalities, we are referring to the rights of individuals to have exclusive use of their property. This includes the right to buy and sell the property. Pollution tends to impact other persons or society overall, so in most cases is illegal and not a right that exists for most property holders.
A free rider is a person who:
receives the benefit of a good but avoids paying for it
