AP Micro Ch 10

Corrective Subsidy

(ideal subsidy=external benefit to society) form of financial aid or support from govt. generally with the aim of internalizing positive externality (give incentive to produce more of the good thing).

Corrective Tax Pigovian Taxes

A tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality (ideal corrective tax=external cost to society). economists prefer tax to regulation b/c it is more efficient. rather than allocating specific amount of pollution allowed, tax allows those w/comparative advantage to pollute much less and avoid tax, and those who cannot will pay. tax places a price on the right to pollute. lowest total cost to reduce pollution comes through tax. no deadweight loss b/c it is societally beneficial to have the tax.

Gas Tax

Aimed at 3 negative externalities: Congestion (traffic, lots of cars on road. tax leads to public transport, carpooling, living closer to work) Accidents (gas-guzzling cars are more likely to kill in pedestrian accident, even if person inside is safer. gas tax means less people buy SUVs) Pollution (more cars make more emissions) gas tax doesn't cause DWL but makes economy work better (cleaner, safer, less traffic)

Internalizing the Externality

Altering incentives so that people take account of the external effects of their actions. When government uses corrective tax to shift supply curve up by the same amount as pollution (supply and social-cost curves should coincide), they are shifting incentives. Now producers will raise their price to reflect the tax, produce less, and consumers will demand less b/c of high price.

Patent Protection

Alternate subsidy method for tech spillover. gives inventors small period of time to be sole producer, they get *property right* of their invention. if other firms wanna use it, they must pay royalty. therefore there is incentive to do their own research and make money.

Negative Externality Example

Automobile Exhaust: creates smog that others have to breathe. Drivers tend to pollute too much. Government solution is to set emission standards for cars and tax gasoline to reduce amount of people that drive. Barking Dog: the dog-owner do not bear the full cost of the noise and don't take precautions to stop barking. Local government solution is to make "disturbing the peace" illegal.

Welfare Economics Review

Demand curve shows value to buyers of aluminium; at each quantity point, the price labelled is that of the marginal buyer, the most they're willing to pay for that specific quantity. Supply Curve, at any given height, shows the cost for the marginal seller, or the cost to the producer of the last aluminium unit sold. Without govt intervention, price adjusts to equilibrium and consumer/producer surplus is maximized.

Social Cost

For each unit produced, social cost is the sum of private costs to aluminium producers plus cost to those bystanders affected by pollution. social cost curve is above supply curve b/c it takes into account the external costs imposed on society by aluminium producers. The difference between the curves, as with tax, shows the cost of the pollution to society.

Adding Negative Externality to Market

For every unit of aluminium produced, some smoke is released. In this case, *the cost to society of producing aluminium is greater than the cost to producers*

Social Value

In case of positive externalities. demand curve does not reflect value of good to society. social value curve is above demand curve b/c its value is greater than private value. Optimal quantity is where supply curve hits social value curve, is greater than market equilibrium. Gap b/w demand and social value curve is the "external benefit" to society. Government can correct market equilibrium by inducing participants to internalize the externality. To move towards optimum value, you must subsidize. (e.g. education is subsidized through public schools and government scholarships)

Market w/Externality

In the presence of externalities, society's interest in a market outcome extends beyond the well-being of buyers and sellers who participate in the market, onto the well-being of bystanders who are indirectly affected. B/c buyers and sellers do not consider outside parties, the market equilibrium is not efficient, b/c it fails to maximize the total benefit to society as a whole. When there's externality it's because some decision maker fails to take account of the external effects of their behavior, and the government responds by trying to influence their behavior to protect the interests of bystanders.

Private Solutions

Moral Codes & Social Sanctions (Golden Rule) Charities (those that help w/externality like pollution) Merging Business (apple and bee farm. on their own, they'll buy too few trees/hives, but once merged they will understand optimal quantity of bees vs apples) Contract (bee and apple make contract saying how many trees and hives the other should buy, and might include payment, therefore internalizes the positive externality)

Optimal Quantity (Negative Externality)

Point where social-cost curve intersects demand curve. If production is below this point, then social cost is less than the value to consumers; above this point, social cost exceeds value to consumers of producing aluminium. Market equilibrium is larger than Optimal quantity b/c consumer value at eq is less than social cost to society, so reducing quantity supplied will be beneficial.

Positive Externality Example

Restored Historic Buildings: positive b/c people who walk by can enjoy them and the sense of history the building provides. Building owners don't get full benefit of restoration and thus tend to demolish old buildings Government solution is to regulate destruction of historic buildings and give tax breaks to owners who restore them. New Tech Research: benefits society. Inventors cannot capture the full benefits of their inventions, tend to devote too few resource to research. Government solution is through patent system, which allows inventors exclusive rights for small period of time. Education: private benefit is that an educated person will get better wages later in life. public externality is that educated population leads to educated voters leads to better government. also lower crime rates. also educated population may encourage new tech development.

Bargaining Breaks Down

This occurs when each side holds out for better deal (e.g. strikes) Especially difficult if there is large number of interested parties, coordinating everyone is costly.

Externality

Type of market failure. The uncompensated impact of one person's actions on the well-being of a bystander. If this effect is adverse, it is negative externality. If beneficial, then positive.

Industrial Policy

When government intervenes in market to promote technology-enhancing industries. Ex) some economists believe that if computer chips yield more spillover than producing potato chips, government should encourage cpu chip production relative to that of potato chips. US tax code does this by offering special tax breaks for expenditures on research and development. It is industrial policy in other nations where government directly subsidizes specific industries which supposedly offer large technology spillovers. Some economists are skeptical about industrial policy, think it's hard to measure the spillovers from each industry, and that govt may end up subsidizing industries just b/c of political influence.

Public Solution to Externality

command-and-control policies regulate behavior directly. to design good rules, regulators need to know details about specific industries and about alternate tech they can adopt--this is difficult info for govt officials to obtain. market-based policy provides incentives for private decision makers to solve problem themselves: corrective tax, tradable pollution permits

Transaction Costs

costs that parties incur in process of agreeing to and following through on a bargain. ex) lawyers needed to draft contracts, translator to bridge language barrier, etc. If transaction costs exceed benefit of the bargain, then deal likely won't take place.

Coase Theorem

if private parties can bargain without cost over the allocation of resource, then the private market will always solve the problem of externalities and allocate resources efficiently. Initial distribution of rights does not matter for the market's ability to reach efficient outcome. However, distribution of rights determines the distribution of economic well-being. Whoever has right will probably be person being paid. Rich owns dog Spot. Jane is disturbed by barking. If benefit to Rich exceeds the cost to Jane, then Spot stays. If Jane values quiet more than Rich values dog, Spot goes. Pay each other so that it's in b/w both of their values, both are better off after transaction.

Technology Spillover

the impact of one firm's research and production efforts on other firms' access to technological advance. Ex) robots. whenever a firm builds a robot, there is chance that it will discover a new/better design. once this design enters society's pool of technological knowledge, it may lead other producers to have positive externality. government may subsidize robots to internalize the externality, at the value of the technology spillover. Then supply curve shifts down and quantity supplied goes up. *technological progress is key to why living standards raise over time*