Chapter 10: Externalities

Question 1

Define ‘Externality’.

Answer 1

The uncompensated impact of one person’s actions on the well-being of a bystander.

Question 2

Define ‘Internalizing the externality’.

Answer 2

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

Question 3

Define ‘Corrective taxes’.

Answer 3

Taxes enacted to correct the effects of negative externalities.

Question 4

Define ‘Coarse theorem’.

Answer 4

The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.

Question 5

Define ‘Transaction costs’.

Answer 5

The costs that parties incur in the process of agreeing to and following through on a bargain.

Question 6

If an activity yields negative externalities, such as pollution, the socially optimal quantity in a market is ___ than the equilibrium quantity. If an activity yields positive externalities, such as technology spillovers, the socially optimal quantity in a market is ___ than the equilibrium quantity.

Answer 6

Less and greater.

Question 7

Governments pursue various policies to remedy the inefficiencies caused by externalities. What are some?

Answer 7

• Prevents socially inefficient activity by regulating behavior.
• Internalizes an externality using corrective taxes.
• Issues permits (i.e. pollution permits). The result is largely the same as corrective taxes.

Question 8

What are some ways that externalities can be solved privately?

Answer 8

• Internalize the externality by merging business.
• Negotiating a contract.
• Etc…