ECON EXAM 3

social value of a good includes

private value - the direct value to buyers external benefit - the value of the positive impact on bystanders

In the presence of a positive externality, the social value of a good includes

private value - the direct value to buyers external benefit - the value of the positive impact on bystanders

Private goods: excludable, rival in consumption Example: food

Public goods: not excludable, not rival Example: national defense

Social cost

= private + external cost

External cost

= value of the negative/positive impact on bystanders

A good is excludable if a person can be prevented from using it.

A good is rival in consumption if one person's use of it diminishes others' use.

When market participants must pay social costs, market eq'm = social optimum

A negative externality exists when the social cost of the good exceeds the private cost.

The Different Kinds of Goods

Private goods: excludable, rival in consumption Example: food Public goods: not excludable, not rival Example: national defense Common resources: rival but not excludable Example: fish in the ocean Club goods: excludable but not rival Example: cable TV

Common resources: rival but not excludable Example: fish in the ocean

Club goods: excludable but not rival Example: cable TV

Effects of Externalities: Summary

If negative externality market quantity larger than socially desirable If positive externality market quantity smaller than socially desirable To remedy the problem, "internalize the externality" tax goods with negative externalities subsidize goods with positive externalities

If negative externality market quantity larger than socially desirable

If positive externality market quantity smaller than socially desirable

The Coase theorem:

If private parties can costlessly bargain over the allocation of resources, they can solve the externalities problem on their own.

Average tax rate total taxes paid divided by total income measures the sacrifice a taxpayer makes

Marginal tax rate the extra taxes paid on an additional dollar of income measures the incentive effects of taxes on work effort, saving, etc.

Private markets tend to over-produce products with negative externalities.

Negative externalities raise social costs above private costs, which means that the social optimum is at an output level that is less than the private output level. Private contracts can increase the well-being of society, as can other types of private solutions.

Tradable Pollution Permits:

Result: Pollution reduction is concentrated among those firms with lowest costs.

Because pollution permits and corrective taxes typically reduce the cost of environmental protection relative to command-and-control policies, the public's desire for a clean environment should increase when permits and taxes replace command-and-control policies.

TRUE Clean air and clean water obey the law of demand: The lower the price of environmental protection, the more the public will want.

Which policy would lead to the socially-optimal level of output?

The vertical distance between the demand curve and social value curve is $16 ($28 - $12). A subsidy of $16 per unit would shift the demand curve upward to coincide with the social value curve. The supply and (shifted) demand curve would intersect at the socially-optimal quantity (Q = 10).

The socially-optimal quantity of output is the quantity at which the social value equals the supply (private cost).

When the private value is less than the social value, a positive externality exists, and the market equilibrium quantity is less than the socially-optimal quantity.

Corrective tax: Also called Pigouvian taxes

a tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality

Internalizing the externality: In our example, the $1/gallon tax on sellers makes sellers' costs = social costs.

altering incentives so that people take account of the external effects of their actions

private cost

supply

private value

demand

The ideal corrective tax = external cost.

ideal corrective subsidy = external benefit

The tragedy of the commons

is an economic theory of a situation within a shared-resource system where individual users acting independently according to their own self-interest behave contrary to the common good of all users by depleting that resource through their collective action.