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Questions and Answers
What defines a negative externality?
What defines a negative externality?
Which of the following is an example of a positive production externality?
Which of the following is an example of a positive production externality?
How does market failure relate to externalities?
How does market failure relate to externalities?
Which scenario best illustrates negative consumption externalities?
Which scenario best illustrates negative consumption externalities?
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What is the relationship between private costs and social costs in the context of externalities?
What is the relationship between private costs and social costs in the context of externalities?
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What is the definition of marginal social cost (MSC)?
What is the definition of marginal social cost (MSC)?
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Which of the following illustrates a negative consumption externality?
Which of the following illustrates a negative consumption externality?
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What is a common outcome when there is a negative production externality?
What is a common outcome when there is a negative production externality?
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What contributes to marginal external costs in production?
What contributes to marginal external costs in production?
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In the example provided, what is the marginal social cost when the output is 4,000 tons of chemicals?
In the example provided, what is the marginal social cost when the output is 4,000 tons of chemicals?
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Study Notes
Market Failure
- Occurs when the market outcome is not the socially efficient outcome.
- Government intervention may be necessary to ensure market efficiency.
- Market fails to reach the "correct" price and quantity.
- Externalities are a common form of market failure.
Externalities
- Costs or benefits that affect individuals other than the producer or consumer.
- Can be positive or negative.
- Negative externalities impose external costs on others.
- Positive externalities create external benefits for others.
Types of Externalities
- Negative Production Externalities: Costs imposed on others by production activities, such as pollution from factories.
- Positive Production Externalities: Benefits to others from production activities, such as training employees or research and development.
- Negative Consumption Externalities: Costs imposed on others by consumption activities, such as secondhand smoke.
- Positive Consumption Externalities: Benefits to others from consumption activities, such as vaccinations or education that benefits society.
Private Costs and Social Costs
- Private Cost: Cost borne by the producer.
- Marginal Private Cost (MC): The cost of producing one more unit of a good or service, borne by the producer.
- External Cost: Cost borne by individuals other than the producer.
- Marginal External Cost: The cost of producing one more unit of a good or service, borne by individuals other than the producer.
- Marginal Social Cost (MSC): The total cost of producing one more unit of a good or service, including both private and external costs.
- MSC = MC + Marginal External Cost
Inefficiency with Negative Externalities
- When there's a negative externality, the market equilibrium quantity is higher than the socially efficient quantity.
- This leads to a deadweight loss, representing the loss of social welfare.
- The socially efficient quantity is where MSC = Marginal Benefit.
Problem 1
- Demand curve for an environmental good: MPB = 24 - 2q
- Marginal Private Cost function: MPC = q
- Marginal Social Cost is double the Marginal Private Cost: MSC = 2q
- To find the market level of output, set MPB = MPC.
- To find the optimal level of output, set MPB = MSC.
- Calculate Consumer Surplus (CS), Producer Surplus (PS), and Deadweight Loss (DWL) at both the market and optimal levels of output.
Problem 2
- Market demand curve for diamonds: PD = 1000 - 2Q
- Market supply curve (marginal cost): PS = 200 + 2Q
- Marginal Social Cost including externalities: MSC = 250 + 2Q
- Calculate:
- Market equilibrium quantity and price.
- Social welfare loss due to the externality.
- Optimal quantity and price.
- The deadweight loss caused by the externality.
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Description
This quiz explores the concepts of market failure, focusing on the inefficiencies that arise when the market does not reach socially optimal outcomes. It delves into the types of externalities, including both negative and positive aspects, along with the importance of government intervention. Test your understanding of these critical economic themes.
