Chapter 17- Externalities & Public Goods

Positive externality:

A benefit conferred on a party not directly involved in a transaction example of a positive externality is education

Negative externality:

A cost imposed on a party not directly involved in a transaction example of a coal-fired power plant

Externalities:

A cost or benefit that affects a party not directly involved in a transaction.

Quota:

A regulation mandating that the production of a certain quantity of a good or externality be limited (negative externality) or required (positive externality).

Pigouvian tax

A tax on an activity that causes a negative externality Serves to account for the external cost imposed on society

public goods

Good that benefits the individual consumer even as others consume it These goods (e.g., national defense, a fireworks display, clean air) remain just as valuable to the consumer, even as other people consume them.

There are two reasons markets will underprovide public goods. FIRST:

If individuals purchase the goods themselves, they will do so only until private marginal benefit equals marginal cost. The efficient level occurs when the total marginal benefits equal marginal cost.

Quantity Mechanisms to Correct Externalities

Quantity-based interventions have the same goal as taxes or subsidies: to move a market with externalities toward the efficient outcome.

What is the nature of the positive externality associated with research and development (R&D)? Firms that engage in R&D tend to pay higher stock dividends. R&D may lead to discoveries that make other firms more innovative. Firms that engage in R&D may be able to lower their production costs. Firms that engage in R&D may develop more profitable products.

R&D may lead to discoveries that make other firms more innovative.

Pigouvian subsidy

Subsidy for an activity that produces a positive externality

Social benefit:

The benefit of a transaction to society, equal to the private benefit plus the external marginal benefit.

Social cost:

The cost of a transaction to society, equal to the private cost plus the external marginal cost.

The most common way that the free-rider problem is dealt with is by government:

The power to tax is often used to provide public goods such as national defense, air traffic control, and weather forecasting.

There are two reasons markets will underprovide public goods. Second:

This is called the free-rider problem: A source of inefficiency resulting from individuals consuming a public good or service without paying for it

nonrival

one individual's consumption of the good does not diminish another consumer's enjoyment of the same good

Competitive markets _____ goods with negative externalities and _____ provide goods with positive externalities. overprovide; underprovide underprovide; overprovide overprovide; overprovide underprovide; underprovide

overprovide; underprovide

If consuming a good with a positive externality, a person will likely consider only the _____ benefits of consuming each unit, which causes _____ consumption than is socially optimal. private, not the external; less external; more external; less private, not the external; more

private, not the external; less

In the case of producing a good with a negative externality, a firm will likely consider only the _____ costs of producing each unit, leading to production of _____. private; less output than is socially optimal private; more output than is socially optimal external; less output than is socially optimal external; more output than is socially optimal

private; more output than is socially optimal

There are no externalities in the market for brim hats; therefore, the: external cost per unit equals the private cost per unit. social benefit equals the external benefit per unit. equilibrium level of output will be too low. social cost per unit equals the private cost per unit.

social cost per unit equals the private cost per unit.