Externalities (Ch 10)

what is the difference between a subsidy and tax

A subsidy to producers creates an incentive to produce more, while a tax creates an incentive to produce less

negative externality

a cost that a third party incurs from someone else's economic activity in the absence of government intervention, the market equilibrium quantity produced will be more than the socially optimal quantity. Graphically, a negative externality places the social cost curve above the private cost curve. the market equilibrium quantity produced is greater than the socially optimal quantity

corrective subsidy

encourages behavior that has positive external effects

a breakdown in bargaining

if the parties haggle for too long over the deal

positive externality

is a benefit that a third party receives from someone else's economic activity Graphically, a positive externality places the social value curve above the private value curve In the presence of a positive externality, the market equilibrium quantity produced is less than the socially optimal quantity

market equilibrium quantity

occurs at the intersection of the private cost curve and the private value curve

socially optimal quantity

occurs at the intersection of the social cost curve and the social value curve

command-and-control policy, or regulation

remedies an externality by legally limiting a specific behavior by a specific entity Some examples of command-and-control policies are directly limiting the emissions of carbon dioxide by each factory or mandating that firms adopt emissions-reducing technology.

tradable permit system

remedies an externality by regulating general behavior, but also by allowing market forces to determine individual outcomes

pigovian tax (corrective tax

see notes for definition discourages behavior that has negative external effects this is a tax equal to the external cost that would cause the socially optimal quantity of steel to be produced For example, since carbon-dioxide pollution generates a social cost beyond the private costs to the factory owner, a corrective tax can help achieve the socially optimal quantity of pollution.

Coase theorem

which asserts that as long as bargaining costs are low enough (they were assumed to be zero in this case), assigning property rights to one party will efficiently solve the problem of externalities (regardless of which party is initially awarded the rights).