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What are the two main types of externalities?
What are the two main types of externalities?
When do externalities arise?
When do externalities arise?
What is the impact of a negative externality?
What is the impact of a negative externality?
Which of the following is NOT a negative externality related to production?
Which of the following is NOT a negative externality related to production?
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Which of the following is NOT a negative externality related to consumption?
Which of the following is NOT a negative externality related to consumption?
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In the absence of externalities, the quantity produced and consumed when the market is in equilibrium is efficient.
In the absence of externalities, the quantity produced and consumed when the market is in equilibrium is efficient.
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If there is a negative externality, the social cost of production is lower than the private cost.
If there is a negative externality, the social cost of production is lower than the private cost.
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If there is a positive externality, the social cost of production is higher than the private cost.
If there is a positive externality, the social cost of production is higher than the private cost.
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The production of aluminum generates positive externalities because of the diffusion of new technologies.
The production of aluminum generates positive externalities because of the diffusion of new technologies.
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The production of robots could generate positive externalities because the diffusion of new technologies can benefit other producers.
The production of robots could generate positive externalities because the diffusion of new technologies can benefit other producers.
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Negative externalities in consumption, such as smoking, lead to a higher social value than a private value.
Negative externalities in consumption, such as smoking, lead to a higher social value than a private value.
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Positive externalities in consumption, such as vaccination, lead to a higher social value than a private value.
Positive externalities in consumption, such as vaccination, lead to a higher social value than a private value.
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When producers and consumers do not take into account the external effects of their choices, they do not produce the optimal quantity.
When producers and consumers do not take into account the external effects of their choices, they do not produce the optimal quantity.
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In the presence of negative externalities, the quantity produced in the market is less than the optimal quantity.
In the presence of negative externalities, the quantity produced in the market is less than the optimal quantity.
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In the presence of positive externalities, the quantity produced in the market is more than the optimal quantity.
In the presence of positive externalities, the quantity produced in the market is more than the optimal quantity.
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What is the objective of internalization?
What is the objective of internalization?
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The Coase Theorem states that if all property rights are well defined and private parties can bargain without cost, they can solve the problem of externalities on their own.
The Coase Theorem states that if all property rights are well defined and private parties can bargain without cost, they can solve the problem of externalities on their own.
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What are Pigouvian taxes?
What are Pigouvian taxes?
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What are Pigouvian subsidies?
What are Pigouvian subsidies?
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What are emissions fees?
What are emissions fees?
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What is the core concept behind cap-and-trade?
What is the core concept behind cap-and-trade?
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Which of these policies is an example of command-and-control regulation?
Which of these policies is an example of command-and-control regulation?
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What are the two main types of command-and-control regulation?
What are the two main types of command-and-control regulation?
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Command-and-control regulations typically use incentive-based mechanisms to regulate polluting activities.
Command-and-control regulations typically use incentive-based mechanisms to regulate polluting activities.
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A technology standard requires a company to install a specific pollution-reducing device or adopt a specific pollution-reducing behavior.
A technology standard requires a company to install a specific pollution-reducing device or adopt a specific pollution-reducing behavior.
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A performance standard sets an emissions goal for each polluter or a group, allowing them to choose their own methods for achieving the target.
A performance standard sets an emissions goal for each polluter or a group, allowing them to choose their own methods for achieving the target.
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Command-and-control methods are typically more cost-effective than market-based solutions.
Command-and-control methods are typically more cost-effective than market-based solutions.
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Command-and-control methods are often favored over market-based solutions because of their simplicity and ease of enforcement.
Command-and-control methods are often favored over market-based solutions because of their simplicity and ease of enforcement.
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Distribution reasons can be a justification for using command and control despite it being less cost-effective than incentive-based regulation.
Distribution reasons can be a justification for using command and control despite it being less cost-effective than incentive-based regulation.
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Study Notes
Market Failure and Public Intervention
- Government intervention is necessary when the free market fails to achieve efficient allocation of goods and services. This is a secondary reason for government intervention.
Market Power (Non-competitive Markets)
- Monopoly: one producer
- Oligopoly: a few producers
- Monopsony: one buyer (common in labor markets)
- Cartels: producers collaborate to set prices
- Product differentiation: firms create perceived differences in products to set prices
Non-existence of Markets
- Asymmetric information: one party has more information than the other
- Public goods: non-rivalrous (one person's consumption doesn't diminish another's) and non-excludable (difficult to prevent people from consuming)
- Externalities: the choices of one party affect others, either negatively or positively
Externalities
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Externalities in production
- Negative externalities:
- Environmental pollution (e.g., aluminum factories)
- Noise from factories
- Traffic Social cost > private cost Example given is pollution of aluminum factories, where social cost = cost of production + cost of pollution
- Positive externalities:
- Research in new technologies
- Improving historical buildings Social cost < private cost Example given is the production of robots, where social cost = cost of production – benefits of new technology diffusion
- Negative externalities:
Negative Externalities (Consumption)
- Smoking
- Drinking alcohol
Positive Externalities (Consumption)
- Vaccination
- Education
Externalities and Economic Welfare
- Market failure is caused by externalities.
- Producers and consumers do not account for the external effects.
- Negative externalities: Market quantity > Optimal quantity.
- Positive externalities: Market quantity < Optimal quantity.
Solutions to Externalities
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1. Property rights:
- Property rights are essential for efficient resource allocation
- Lack of established property rights leads to market failure
- Government intervention is needed to establish property rights and resolve the market failure
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2. Internalization of Externalities:
- Modifying agents' incentives so they account for external effects of their choices
- External effects are turned into private costs.
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2.1. Private solutions (the Coase theorem):
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If property rights are defined, parties can bargain to solve the problem of externalities. The initial distribution of rights does not affect the efficient outcome.
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Example illustrated with noisy bar and neighbor.
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2.2. Public solutions:
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Policies based on the market:
- Pigouvian taxes (to correct negative externalities)
- Pigouvian subsidies (to correct positive externalities)
- Tradable permits (cap-and-trade mechanisms)
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Measures of command-and-control:
- Forbid certain activities (e.g., pollution above a certain level) or make activities compulsory (e.g., vaccination)
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Public policies to solve externalities:
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Pigouvian taxes
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Emissions fees
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Cap and Trade
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Command and Control Regulation
- Technology standards
- Performance standards
Pigouvian taxes:
- Developed by Arthur Pigou.
- Taxing those who generate negative externalities to discourage harmful activity.
- In example, taxing factory pollution to get them to internalize costs.
Emission Fees:
- A tax placed on each unit of emissions.
- Better than Pigouvian taxes in many cases because the fees adjust to account for different reduction costs across companies, leading to the cost-effective reduction in aggregate.
Cap and Trade:
- A cap is set on total permissible pollution and rights to pollute are given to producers for trade among them
- Cost effective way of achieving pollution reduction targets
- Companies with higher costs of reduction can acquire permits from companies with lower costs saving overall reduction costs.
Regulations (Command and Control):
- Technology standards: Companies must install pollution-reducing devices.
- Performance standards: Sets emissions goals for polluters.
Monitoring Ease/Cost:
- Monitoring incentives is often more costly than regulating technologies directly.
Distributional Reasons:
- Incentive-based methods tend to concentrate pollution in certain localized areas (hot spots)
- Command-and-control regulations tend to spread the costs more evenly across polluters.
Summary of Externalities:
- Externalities affect other people through regular market mechanisms.
- Loss of welfare directly impacting production.
- Lack of property rights is the root cause of the market's failure.
- Externalities are solved by internalization (private and public solutions).
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Description
This quiz explores the concepts of market failure and the necessity of government intervention in non-competitive markets. It covers various forms of market power, externalities, and the challenges posed by asymmetric information. Test your understanding of these economic principles and their implications.
