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Questions and Answers
The socially optimal quantity in the presence of a negative externality is:
Which of the following policies is an example of a market-based approach to reducing pollution?
According to the Coase Theorem, private solutions to externalities work best when:
Corrective taxes (Pigovian taxes) are used to:
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Which of the following is a reason why private solutions to externalities do not always work?
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Public goods are both non-excludable and non-rival in consumption, meaning they can be consumed by many people without reducing availability to others.
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The free-rider problem occurs when individuals receive the benefits of a good without paying for it, leading to under-provision of that good in a market economy.
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Common resources are non-excludable but rival in consumption, leading to overuse and depletion.
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Fireworks displays are an example of a private good because the enjoyment of the display is exclusive to those who pay for it.
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The tragedy of the commons refers to the tendency for common resources to be overused and depleted because no one individual has an incentive to conserve them.
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Study Notes
Socially Optimal Quantity
- The socially optimal quantity is the amount of a good or service that maximizes social welfare, considering both private costs and benefits as well as external costs.
- In the presence of a negative externality, the socially optimal quantity is less than the market equilibrium quantity.
- This is because the market equilibrium does not account for the external costs imposed by the production or consumption of the good.
Market-Based Solutions to Pollution
- Market-based approaches to reducing pollution use economic incentives to encourage polluters to reduce their emissions.
- Examples include pollution taxes, cap-and-trade systems, and subsidies for environmentally friendly technologies.
Coase Theorem
- The Coase Theorem states that private solutions to externalities are possible when:
- Property rights are well defined.
- Transaction costs are low.
- This means that bargaining between the parties involved can lead to an efficient outcome, even in the presence of externalities.
Corrective Taxes
- Corrective taxes, also known as Pigovian taxes, are taxes levied on activities that generate negative externalities.
- They are designed to internalize the external costs of these activities, bringing the market price closer to the socially optimal price.
Limitations of Private Solutions
- One reason why private solutions to externalities do not always work is that transaction costs can be high.
- Other reasons include:
- Difficulty in defining property rights.
- Information asymmetry.
- Free riding.
Public Goods
- Public goods are non-excludable, meaning that it is difficult or impossible to prevent individuals from consuming them, even if they do not pay for them.
- Public goods are also non-rivalrous, meaning that one person's consumption of the good does not reduce the amount available for others.
- Examples include national defense, clean air, and public broadcasting.
Free-Rider Problem
- The free-rider problem arises because individuals can benefit from a public good without contributing to its provision.
- This can lead to under-provision of public goods in a market economy, as individuals are less likely to pay for something they can get for free.
Common Resources
- Common resources are non-excludable, but rival in consumption, meaning that one person's use of the resource reduces the amount available for others.
- This can lead to over-exploitation of common resources, a concept known as the tragedy of the commons.
- Examples include fisheries, forests, and grazing land.
Fireworks Displays - Private Good Example
- Fireworks displays are an example of a private good, as their enjoyment is exclusive to those who pay for them.
- This is because the benefits are limited to those who are able to see and hear the fireworks display.
Tragedy of the Commons
- The tragedy of the commons refers to the tendency for common resources to be overused and depleted because no individual has an incentive to conserve them.
- Each individual focuses on their own short-term gain, leading to the depletion of the resource in the long run.
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