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Questions and Answers
What is a key characteristic of an externality?
What is a key characteristic of an externality?
- It is fully accounted for in the decision-making process of those creating it.
- It only has negative consequences for society.
- It is the cost or benefit imposed on a third party not involved in the decision-making. (correct)
- It directly affects all parties involved in a transaction.
How do negative externalities typically affect production or consumption levels?
How do negative externalities typically affect production or consumption levels?
- They lead to underproduction and underconsumption.
- They have no impact on production or consumption.
- They result in optimal levels of production and consumption.
- They cause overproduction and overconsumption. (correct)
What is the 'Tragedy of the Commons' an example of?
What is the 'Tragedy of the Commons' an example of?
- A positive externality leading to underinvestment.
- A situation where private and social costs are perfectly aligned.
- An efficient allocation of resources in a market economy.
- A negative externality leading to overuse of a shared resource. (correct)
In a market with a negative externality, what does the difference between the private cost and social cost represent?
In a market with a negative externality, what does the difference between the private cost and social cost represent?
How does the presence of a negative externality typically affect the efficient quantity of a good or service?
How does the presence of a negative externality typically affect the efficient quantity of a good or service?
How can Pigouvian taxes correct market distortion?
How can Pigouvian taxes correct market distortion?
What is a potential problem with using Pigouvian taxes to correct externalities if demand is price-inelastic?
What is a potential problem with using Pigouvian taxes to correct externalities if demand is price-inelastic?
In the context of externalities and Pigouvian taxes, what is the primary goal of taxation?
In the context of externalities and Pigouvian taxes, what is the primary goal of taxation?
What is a key difference between using Pigouvian taxes and permits/vouchers to address externalities?
What is a key difference between using Pigouvian taxes and permits/vouchers to address externalities?
What does assigning property rights do in the context of externalities?
What does assigning property rights do in the context of externalities?
When property rights are well-defined and transaction costs are low, what does the Coase Theorem predict about the efficient outcome?
When property rights are well-defined and transaction costs are low, what does the Coase Theorem predict about the efficient outcome?
What is a necessary condition for the Coase Theorem to hold true?
What is a necessary condition for the Coase Theorem to hold true?
According to the Coase Theorem, who should be assigned property rights to achieve an efficient outcome in the presence of externalities?
According to the Coase Theorem, who should be assigned property rights to achieve an efficient outcome in the presence of externalities?
In a situation with a negative externality, if property rights are given to the party harmed by the externality, what is likely to happen?
In a situation with a negative externality, if property rights are given to the party harmed by the externality, what is likely to happen?
What is the role of transaction costs in the context of the Coase Theorem?
What is the role of transaction costs in the context of the Coase Theorem?
What is an example of a 'technical removal' solution to an externality?
What is an example of a 'technical removal' solution to an externality?
How do effluent fees work as a solution to externalities?
How do effluent fees work as a solution to externalities?
What is an example of regulation used to address externalities?
What is an example of regulation used to address externalities?
Why might simply removing an externality (technically) not always be feasible or desirable?
Why might simply removing an externality (technically) not always be feasible or desirable?
Which of the following is an example of a positive externality?
Which of the following is an example of a positive externality?
Which of the following statements best describes the impact of externalities on market efficiency?
Which of the following statements best describes the impact of externalities on market efficiency?
What is the primary function of a Pigouvian tax in relation to negative externalities?
What is the primary function of a Pigouvian tax in relation to negative externalities?
Why might a Pigouvian tax be ineffective if demand for the taxed good is perfectly inelastic?
Why might a Pigouvian tax be ineffective if demand for the taxed good is perfectly inelastic?
In what scenario would the allocation of property rights NOT affect the level of pollution, according to the theory discussed?
In what scenario would the allocation of property rights NOT affect the level of pollution, according to the theory discussed?
Under what conditions does the Coase Theorem suggest that private bargaining can resolve externalities?
Under what conditions does the Coase Theorem suggest that private bargaining can resolve externalities?
What does it mean to 'technically remove' an externality, and why might it be challenging in practice?
What does it mean to 'technically remove' an externality, and why might it be challenging in practice?
In the context of airline seat design as a 'technical removal' of an externality, what is the key idea?
In the context of airline seat design as a 'technical removal' of an externality, what is the key idea?
What is the primary goal of implementing effluent fees?
What is the primary goal of implementing effluent fees?
How does government regulation address externalities?
How does government regulation address externalities?
If a firm's production imposes a negative externality on society, its private marginal cost (PMC) is typically what compared to its social marginal cost (SMC)?
If a firm's production imposes a negative externality on society, its private marginal cost (PMC) is typically what compared to its social marginal cost (SMC)?
How do positive externalities affect the quantity of a good or service produced in a free market compared to the socially optimal quantity?
How do positive externalities affect the quantity of a good or service produced in a free market compared to the socially optimal quantity?
When economists say that externalities cause 'market failure', what do they mean?
When economists say that externalities cause 'market failure', what do they mean?
What are the two main criteria that must be satisfied for the Coase Theorem to result in the efficient allocation of resources to address an externality?
What are the two main criteria that must be satisfied for the Coase Theorem to result in the efficient allocation of resources to address an externality?
What is the intention of setting a Pigouvian tax equal to the marginal external cost?
What is the intention of setting a Pigouvian tax equal to the marginal external cost?
Select the best real-world example of the tragedy of the commons.
Select the best real-world example of the tragedy of the commons.
How might the design of a product (e.g., redesigning airplane seats) serve as a 'technical removal' of a negative externality?
How might the design of a product (e.g., redesigning airplane seats) serve as a 'technical removal' of a negative externality?
Why might assigning property rights fail to address externality issues in practice?
Why might assigning property rights fail to address externality issues in practice?
Flashcards
What are externalities?
What are externalities?
A cost or benefit imposed on a third party not involved in the decision-making.
Positive vs. Negative Externalities
Positive vs. Negative Externalities
Externalities can be positive, like herd immunity from vaccinations, or negative, like pollution.
Externalities: Key Finding
Externalities: Key Finding
If negative externality: overproduction/consumption. If positive externality: underproduction/consumption
Tragedy of the Commons
Tragedy of the Commons
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Pigouvian Tax
Pigouvian Tax
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(Pigouvian) tax: fixing prices
(Pigouvian) tax: fixing prices
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Permits/vouchers: fixing quantity
Permits/vouchers: fixing quantity
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Coase Theorem
Coase Theorem
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Coase Theorem: costless bargaining over externalities
Coase Theorem: costless bargaining over externalities
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Technical Externality Removal
Technical Externality Removal
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Effluent Fees
Effluent Fees
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Regulation
Regulation
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Study Notes
- The topic of the lecture is externalities.
Externalities
- Externalities are a cost or benefit imposed on a third party not involved in the decision-making process.
- Externalities can be either positive or negative.
- Externalities can be related to any decision or activity, such as production or consumption.
- Examples of externalities include the Covid-19 pandemic, face masks, vaccinations (herd immunity), and social distancing.
Why are externalities a problem?
- Negative externalities lead to overproduction or overconsumption.
- Positive externalities result in underproduction or underconsumption.
- A specific example of a problem caused by externalities is the Tragedy of the Commons. This is where a shared, limited resource is overused and depleted.
Solutions for Externalities
- Solutions for externalities include pigouvian tax, property rights (Coase Theorem), and removing them technically (effluent fees, regulation).
- (Pigouvian) tax helps distort the market, and this leads to a better world.
- Pigouvian tax fixes prices by setting tax equal to marginal external cost, induces the optimal quantity, and is Pareto efficient.
- However, there's a few misunderstandings about pigouvian taxation: widespread negative externality observed, outcome cannot be socially optimal, tax is imposed because of externality, tax revenue must be used to reduce the negative externality.
- Tax to reduce negative externality might be ineffective if demand is price-inelastic.
- Permits/vouchers: fixing quantity by allocating socially optimal quantity as permits and allow trade, permit price will be equal to marginal external cost, and is Pareto efficient.
Property Rights and Externalities
- Consider two agents with smoke and money. Smoke and money are goods for agent A, but money is good and smoke is bad for agent B. Smoke is a public commodity.
- Assume no property rights are assigned, so there is no way to exchange money for changes in smoke levels.
- Without property rights, and trading 'money for smoke' outcome is inefficient.
- With Coase, assign property rights to internalize external costs.
- Assign ownership of the air to B: B has right to clean air, but can sell allowances to smoke to A
- Assign ownership of the air to A: A has right to smoke, but can sell allowances of clean air to B
- p(sA) refers to the price paid by A to B to create smoke intensity sA.
- Getting property rights leads to Pareto efficient allocation.
- if preferences are quasilinear in money, then (the same) efficient level of externality is produced no matter which agent is assigned the property rights
- Coase Theorem is: costless bargaining over externalities achieves some Pareto efficient outcome, independent from who gets the property rights, conditions: no transaction costs and no other frictions
Other Solutions
- Other solutions to externalities includes: remove them technically, effluent fees, and regulation.
Next Week
- The topic for the next lecture is public goods. It will cover what happens if positive externalities are overwhelming.
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