ECON: Chapter 10: Externalities and Public Good

3 facts about public goods

1. just because the government provides it, doesn't man that it is a public good - Ex: mail delivery 2. just because something is a public good doesn't mean that the government should fund it - Ex: parks 3. just because the government should fund a public good doesn't mean that the government should provide it - Ex: fireworks display

3 steps to analyze externalities

1. predict the equilibrium outcome to forecast what you think will happen 2. assess what externalities are involved 3. figure out what outcome is in society's best interests, and then compare this to the equilibrium forecast from the first step

6 ways to solve external problems by "internalizing the externality"

1. private bargaining 2. fix the price: corrective taxes and subsidies 3. fix the quantity: cap and trade 4. laws, rules, and regulations 5. government provision of public goods 6. assign ownership rights

external benefit:

a benefit accruing to bystanders

external cost:

a cost imposed on the bystanders

nonrival good:

a good for which one person's use doesn't subtract from another's

rival good:

a good for which your use of it comes at someone else's expense

club good:

a good that is excludable but nonrival in consumption - ex: cable TV

common resourse:

a good that is rival and also nonexcluable - ex: fish, town commons

cap and trade:

a quantity regulation implemented by allocating a fixed number of permits, which can then be traded - similar to a corrective tax

externality:

a side effect of an activity that affects bystanders whose interests aren't taken into account

free-rider problem:

a situation that arises when someone can enjoy the benefits of a good without bearing the cost

corrective tax:

a tax designed to induce people to take account of the negative externalities they cause

marginal social benefit:

all marginal benefits, no matter who gets them

marginal external cost:

all marginal costs, no matter who pays them

positive externality:

an activity whose side effects benefit bystanders

negative externality:

an activity whose side effects harm bystanders

on a graph positive externalities

drive a wedge between marginal social benefits and the demand curve

on a graph, negative externalities do what

drive a wedge between the supply curve and the marginal social cost curve the

coase theorem:

if bargaining is costless, property rights are clearly established and enforced, and externality problems can be solved by private bargains

equation for marginal social benefits

marginal social benefits = marginal private benefit + marginal external benefit

equation for marginal social cost

marginal social cost = marginal private cost + marginal social cost

public goods:

nonrival goods afflicted by the free-rider problem - Ex: national security

free-rider problems typically come up when

people cannot be easily excluded from using something

the rational rule for society:

produce more of a product as lone as its marginal social benefit is at least as large as the marginal social cost

marginal private benefit:

the external benefit from one extra unit enjoyed by the buyer

marginal private cost:

the extra cost from one extra unit paid by the seller

marginal external benefit:

the extra external benefit from one extra unit

there is no free-rider problem when

the goods and services are rival because it's easy to exclude someone

socially optimal:

the outcome that is most efficient for society as a whole, including the interests of buyers, sellers, and bystanders

tragedy of the commons:

the tendency to overconsume a common resource

when people don't take account of the marginal external benefits that their choices generate...

they will buy a smaller quantity than is in society's best interest

goods that create positive externalities are often

under produced