Econ > [MAR] - Externalities > Flashcards

[MAR] - Externalities Flashcards

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1
Q

What is market failure ?

A
  • the failure of the markets to achieve allocative efficiency
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2
Q

What is Marginal Private Benefit and what is the nature of its curve (MPB) ?

A
  • marginal private benefit additional benefit to consumers of consuming an extra unit of output
  • its curve is the same as the demand curve
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3
Q

Is the MPB curve upward or downward sloping ?

A
  • downward sloping
  • like the demand curve
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4
Q

What is Marginal Social Benefit (MSB) ?

A
  • marginal social benefit is the additional benefit to society of consuming an extra unit of output
  • MSB = MPB + MEB
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5
Q

What is the equation for MSB ?

A
  • MSB = MPB + MEB
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6
Q

What is Marginal Private Cost (MPC) ?

A
  • marginal private cost is the additional cost to producers of producing an extra unit of output
  • like the supply curve
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7
Q

Is the curve for marginal private cost (MPC) upward or downward sloping ?

A
  • upward sloping
  • like the supply curve
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8
Q

What is Marginal Social Cost (MSC) ?

A
  • the additional cost to society of producing an extra unit of output
  • MSC = MPC + MEC
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9
Q

What is the equation for MSC ?

A
  • MSC = MPC + MEC
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10
Q

What does MEC stand for ?

A
  • marginal extra cost
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11
Q

What does MPB stand for ?

A
  • marginal private benefit
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12
Q

What does MSB stand for ?

A
  • marginal social benefit
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13
Q

What does MPC stand for ?

A
  • marginal private cost
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14
Q

What does MSC stand for ?

A
  • marginal social cost
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15
Q

What does MPC stand for ?

A
  • marginal private cost
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16
Q

What is the MEC ?

A
  • MEC is the cost to (mainly) others of you consuming / producing an extra unit of output
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17
Q

When is allocative efficiency achieved ?

A
  • allocative efficiency is achieved when social / community surplus is maximized
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18
Q

What is allocative efficiency ?

A
  • allocative efficiency is when just the right amount of goods and services are being produced from society’s point of view
  • it occurs when the socially optimum level of output (where MSB = MSC) is reached
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19
Q

When is the socially optimum level of output reached ?

A
  • when MSB = MSC
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20
Q

Using a diagram, explain where allocative efficiency occurs

A
  • draw:
  • 1) label x-axis quantity; label y-axis price cost benefit of good
  • 2) supply curve, labeled S = MPC = MSC
  • 3) demand curve, labeled D = MPB = MSB
  • 4) label a price and quantity where S and D intersect
  • write:
  • 5) socially optimum level output is reached where S = D (where the curves intersect)
  • 6) no reallocation can make society better off
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21
Q

What are externalities ?

A
  • externalities are external costs or benefits to third parties when a good or service is consumed or produced
  • externalities cause MSC to not equal MPC or MSB to not equal MPB
  • this leads to allocative inefficiency and market failure
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22
Q

What do externalities cause ?

A
  • externalities cause MSC to not equal MPC or MSB to not equal MPB
  • this leads to allocative efficiency and market failure
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23
Q

What does MSC not being equal to MPC and MSB not being equal to MPB lead to ?

A
  • allocative inefficiency + market failure
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24
Q

What are positive externalities of consumption ?

A
  • positive externalities of consumption are the positive spillover effects on third parties that occur when a good / service is consumed
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25
What are merit goods ?
- merit goods are goods and services that are deemed to be desirable - they often have positive externalities of consumption - they are considered to be underconsumed / underproduced by the free market
26
Do merit goods often have positive or negative externalities of consumption ?
- positive externalities of consumption
27
Are merit goods considered underconsumed / overconsumed and underproduced / overproduced by the free market ?
- merit goods are underconsumed and underproduced by the free market
28
What are some examples of merit goods ?
- healthcare - education
29
What are the private benefits of vaccines ?
- you will be protected from infectious diseases - you will be less unwell - so lower healthcare costs for you
30
What are four external benefits of vaccines ?
- 1) less illness within workforce: - so higher labour productivity - so there is economic growth - 2) less illnesses within society: - so less strain on health services - so lower healthcare cost for others - 3) can prevent societies from lockdown - 4) reduced disease transmission to unvaccinated individuals
31
Using an externalities diagram, explain how market failure may exist in the market for vaccines
- draw: - 1) label x-axis quantity of vaccines; label y-axis price cost benefit of vaccines - 2) supply curve labeled S = MPC = MSC - 3) label one demand curve D = MPB and another - which is shifted outwards - D = MSB - 4) welfare loss is the triangle left of the S = MSC and above S = MPB - 5) where S = MPB, Pe = Qe and where S = MSB, P* = Q* - 6) label the difference between D = MPB and D = MSB the ‘positive externality’ - write: - 7) vaccines are merit goods with positive consumption externalities, so MSB > MPB - 8) the free market equilibrium occurs were MPB = MPC at Pe, Qe - 9) the socially optimum level of output occurs where MSB = MSC at P*, Q* - 10) since MSB > MPB, the market equilibrium quantity is less than the socially optimum quantity (Qe > Q*) - 11) there is an underallocation of resources, which results in welfare loss and market failure
32
What are positive externalities of production ?
- the external benefit from producing a good / service on third parties
33
What are some examples of goods and services with positive externalities of production ?
- research and development - vocational training - honey
34
What are the three private costs of producing goods, using honey as an example ?
- 1) labour costs - harvesting honey, looking after the bees - 2) land costs -renting land for hives - 3) capital - hives, tools for extracting honey, jars
35
What are the positive externalities of producing goods, using honey as an example ?
- breeding bees promotes biodiversity - allows for production of crops and fruits at a much larger scale - farmer incomes increase - cost per unit to customers decreases
36
Using an externalities diagram, explain how market failure may exist in the market for honey
- draw: - 1) externality diagram with two S curves: S = MSC which is shifted inwards to S = MPC - 2) label positive externality (MEB) between S = MSC and S = MPC - 3) label welfare loss left of D = MSC and below D = MPC - write: - 4) honey production has positive externalities so MPC > MSC - 5) the free market is producing at MPB = MPC (Pe, Qe) - 6) allocative efficient occurs at MPB = MSC (P*, Q*) - 7) free market quantity < socially optimum quantity - so there is an underallocation of resources; market failure; and welfare loss - 8) the welfare loss occurs because units of honey produced between Qe and Q* have MSB > MSC
37
Why is there an underallocation of resources; market failure; and welfare loss due to positive externalities ?
- because when a good has positive externalities, the allocative efficiency point > free market point
38
Why does welfare loss occur for goods with positive externalities ?
- welfare loss occurs because units consumed / produced of a good between Qe and Q* have MSB > MSC
39
What are the axes labels for externality diagrams ?
- x-axis: quantity of good - y-axis: price cost benefit of good
40
Where is the welfare loss triangle for consumption positive externalities ?
- left of S = MSB - above S = MPB
41
Where is the welfare loss triangle for production positive externalities ?
- left of D = MSC - below D = MPC
42
Where does the welfare loss triangle always point towards ?
- the socially optimum level
43
What are the 4 main policies used to correct positive externalities ?
- 1) subsidies - 2) government provision - 3) awareness creation - 4) legislation and regulation
44
How can subsidies help correct positive consumption and production externalities ?
- subsidies decrease firms’ production costs - this shifts the supply curve outwards from S = MPC = MSC to S = S + subsidy (by the amount of the subsidy) - ideally, S shifts to the socially optimum quantity - if it does, there is no longer an underallocation of resources - and so welfare loss is eliminated - so allocative efficiency is achieved
45
How much is the supply curve shifted when subsidies are used to correct positive externalities ?
- the supply curve is shifted by the amount of the subsidy
46
What are the 5 limitations of using subsidies ?
- 1) strong opportunity cost for the government - they could spend the money on other public services - 2) subsidies are often paid to high-income groups - 3) subsidies can lead to a welfare loss when inefficient producers are drawn into the market - 4) hard to know the right subsidy amount - 5) if demand is price inelastic, larger subsidies are required to increase output
47
Why are subsidies an effective policy for correcting positive externalities ?
- subsidies provide a financial incentive for producers to increase output and consumers to increase consumption of the subsidised good
48
What are 3 advantages of using subsidies to correct positive externalities ?
- 1) subsidies create direct financial incentives to increase output and capture the welfare loss from externalities - 2) low-income consumers benefit from lower-priced goods - 3) producers will be encouraged to increase output, which creates employment
49
What is government provision ?
- governments choose to provide merit goods (and other goods) with significant positive externalities in the public sector
50
How can government provision help correct positive consumption and production externalities ?
- direct provision increases supply - shifting the MPC curve outwards - ideally, shifting MPC to the socially optimum quantity - if MPC reaches socially optimum quantity, welfare loss is eliminated - and so allocative efficiency is achieved
51
Which two positive externality policies shift MPC outwards to MSC ?
- 1) subsidies - 2) government provision
52
What are 3 advantages of using government provision to correct positive externalities ?
- 1) most direct way of increasing output towards the socially efficient level - 2) the state is more likely than the private sector to make decisions in the public’s interest - 3) goods can be provided at the price (or zero price) that all households can afford
53
What are the 4 limitations of using government provision to correct positive externalities ?
- 1) opportunity cost to government - 2) government provision may be less efficient than private sector provision - 3) state-run organisations are often subject to political inteference - 4) difficult to work out how much the government should provide (leading to overallocation and inefficiency)
54
Why may government provision be less efficient than private-sector provision ?
- political interference (making decisions for political reasons rather than efficiency) - lack of competition due to state provision - weak incentives for efficiency - government may not know how much to provide
55
What is regulation used to correct positive externalities ?
- governments believe that consuming some goods is so important that they force people to consume them - this is particularly the case with primary and secondary school education
56
What is a main example of command and control regulation being used to correct positive externalities ?
- primary and secondary school education
57
How can command and control regulation help correct positive consumption externalities ?
- governments use legislation to promote merit goods - this causes MPB curve to shift outwards - ideally, the MPB curve would shift to the MSB curve - if so, the socially optimum quantity is produced and consumed - so, welfare loss is eliminated - same diagram as awareness creation
58
Which two policies to correct positive externalities shift the MPB curve outward to the MSB curve ?
- 1) awareness creation - 2) command and control regulation and legislation (CCRL)
59
What are 2 advantages of using regulation to correct positive externalities ?
- 1) laws force individuals and businesses to make decisions that achieve the socially efficient level - 2) regulations can be targeted precisely at goods and services
60
What are the 5 limitations of using regulation to correct positive externalities ?
- 1) cost of policing and enforcing regulations - 2) opportunity cost of policing and enforcing regulations - 3) regulations add to business costs - 4) some may choose to break the law (particularly if penalties aren’t harsh) - 5) potential political pushback (depending on the good being regulated)
61
What is awareness creation / increasing demand ?
- governments can try to increase the demand for goods associated with positive externalities to move production and consumption towards the socially efficient level of output
62
How can awareness creation help correct positive consumption externalities ?
- governments can educate society about benefits of merit goods - these campaigns increase demand, so the MPB curve shifts outwards - ideally, the MPB curve shifts to MSB - if so, the socially optimum level of output is reached - and so, welfare loss is fully eliminated - so allocative efficiency is reached
63
What are 3 advantages of using awareness creation to correct positive externalities ?
- education and advertising are not as expensive as using subsidies - education and advertising do not have the management problems (costs) of regulation - effective in changing human behaviour, so it’s an effective long-term solution
64
What are 6 disadvantages of using awareness creation to correct positive externalities ?
- 1) cost to government of funding ads / educational programmes - 2) opportunity cost to government - 3) not easy to measure its effectiveness - 4) takes time for behaviour to change - 5) people become immune to advertisements - 6) could lead to an increase in prices - good becomes less affordable
65
Which curve shifts in awareness creation positive externality diagram ?
- MPB shift outwards to MSB
66
Which curve shifts in CCLR positive externality diagram ?
- MPB shift outwards to MSB
67
Which curve shifts in subsidies positive externality diagram ?
- MPC shifts outwards to MSC
68
Which curve shifts in government provision positive externality diagram ?
- MPC shifts outwards to MSC
69
Where is the market equilibrium on an externalities diagram ?
- MPB = MPC
70
Where is the socially efficient level of output on an externalities diagram ?
- MSB = MSC
71
What are third parties ?
- a third party is someone other than producers and consumers of a good / service in a market
72
What are negative externalities ?
- negative externalities are the spillover effects that negatively impact third parties, resulting from the consumption and production of a good / service
73
What are negative externalities of consumption ?
- negative externalities of consumption are negative spillover effects on third parties that occur when a good or service is consumed
74
What are demerit goods ?
- demerit goods are goods that are / have: - deemed socially undesirable (because their consumption is associated with significant social costs) - negative externalities of consumption - overproduced / overconsumed by the free market
75
Why are demerit goods deemed socially undesirable ?
- because their consumption is associated with significant social costs
76
Do demerit goods have positive / negative externalities of consumption / production ?
- negative externalities of consumption / production
77
What are some examples of demerit goods ?
- alcohol - cigarettes
78
What are the private benefits of consuming alcohol ?
- pleasure - stress reduction
79
What are 4 negative externalities of consuming alcohol ?
- 1) crime - 2) anti-social behavior - 3) reduced productivity - 4) strain on healthcare services
80
Why are demerit goods an example of market failure ?
- they tend to be over-consumed in free markets
81
Using an externalities diagram, explain how market failure may exist in the market for alcohol
- draw: - 1) externality diagram with MPB > MSB and S = MPC = MSC - 2) welfare loss drawn - 3) MEC labeled between D = MPC and D = MSB - write: - 4) socially optimum quantity < free market quantity (by the size of the externality) - 5) since alcohol is a demerit good, it has a negative externality, so MPB > MPC - 6) since MPB > MPC, the free market is overproducing alcohol - 7) allocative efficiency occurs at MSB = MSC, so there is also overconsumption - 8) so there is a welfare loss where MSC > MSB
82
What are negative externalities of consumption ?
- negative externalities of consumption are the negative spillover effects from producing a good on third parties
83
What are 3 examples of negative externalities of production ?
- air pollution - water pollution - noise pollution
84
What are 3 private costs of producing beef ?
- 1) land: farmland needed for cows - 2) labour: farmers - 3) capital: infrastructure to maintain / feed cows
85
What are 3 negative externalities of producing beef ?
- deforestation for land - noise pollution from cows - greenhouse gas emissions
86
Using an externalities diagram, explain how market failure may exist in the market for beef
- draw: - 1) externality diagram with S = MSC to the left of S = MPC (MSC > MPC) and D = MPB = MSB - 2) welfare loss triangle pointing towards the socially efficient level of output - 3) negative externality (MEC) labelled between MSC and MPC - write: - 4) the production of beef has negative externalities, since MSC > MPC - 5) the free market is producing at MPB = MPC, at quantity Q (where Q > Qe) - 6) socially optimum level of output is at MSB = MSC, at quantity Qe - 7) since Q > Qe, resources are overallocated to the production of beef and there is a welfare loss - 8) so there is a market failure
87
What are 6 policies to correct negative externalities ?
- 1) indirect taxes - 2) CCLR - 3) awareness creation - 4) international agreements - 5) collective self-governance - 6) tradable permits
88
When do governments impose indirect taxes on producers ?
- when the producer’s industry is associated with negative externalities
89
What does adding an indirect tax do to the negative production externalities diagram ?
- S = MPC = MSC shifts outwards to S = MSC = MPC + tax - D = MSB to the left of D = MPB - price increases from P to P1 - output falls from Q to Q1 - market is closer to the socially efficient level
90
Using an externality diagram, explain how indirect taxes can correct negative consumption and production externalities ?
- draw: - 1) negative externality of consumption diagram - 2) negative externality of production diagram - 3) label S + tax on both - 4) welfare loss pointing towards socially optimum level on both - 5) MEC between S + tax and S = MPC = MSC on both - write: - 6) indirect taxes cause the MPC curve to shift upwards (by the amount of the indirect tax) - 7) ideally, the indirect tax is equal to the MEC, so MSC = MPC - 8) if so, quantity produced / consumed = socially optimum quantity - 9) so welfare loss is eliminated - 10) so allocative efficiency is achieved
91
What are 3 advantages of using indirect taxes to correct negative consumption and production externalities ?
- 1) taxes increase prices, which is an effective way of reducing consumption and production (due to higher costs) - 2) tax revenues can be used to compensate affected third parties - 3) tax revenues can be used to pay for the externality’s negative consequences
92
What are 9 disadvantages of using taxes to correct negative externalities ?
- 1) may be ineffective for inelastic goods - because consumption won’t change and market failure won’t be corrected - 2) parallel markets can develop - 3) difficult to know where the socially efficient level of output is - so market failure may not be fully corrected - 4) cost to governments of collecting taxes - 5) opportunity cost to government of collecting taxes - 6) tax collection may be inefficient - 7) taxes cause firms to reduce output and move overseas - this leads to greater unemployment - 8) taxes are regressive - so more impact on low income consumers - 9) political problems
93
Why are indirect taxes ineffective for correcting inelastic goods with negative externalities ?
- because the consumption of inelastic goods doesn’t change very much - so market failure isn’t corrected
94
Why is firms reducing output / moving overseas a limitation of using indirect taxes to correct negative externalities ?
- leads to greater unemployment
95
Why is being regressive a limitation of using indirect taxes to correct negative externalities ?
- more impact on low-income consumers
96
How can governments use regulation to correct production external costs ?
- governments can regulate production externalities by requiring firms to comply with specific laws and regulations when producing goods and services
97
Explain an externality diagram showing the effect of using regulations to correct negative consumption externalities
- x-axis: quantity of good, y-axis: price cost benefit of good - S = MPC = MSC - D = MSB with D = MPB shifted outwards (MPB to the right of MSB)
98
Explain an externality diagram showing the effect of using regulations to correct negative production externalities
- x-axis: quantity of good, y-axis: price cost benefit of good - D = MPB = MSB - S = MPC shifted inwards to S = MSC (MPC to the right of MSC)
99
What are 2 advantages of using regulation, compared to indirect taxes, in correcting negative externalities ?
- 1) regulation be targeted more specifically at negative externalities - eg banning a good is more effective than taxing it, in order to reduce negative production externalities - 2) regulation is less likely to lead to an increased price than a tax, if firms can comply with the regulation relatively easily
100
What are 5 disadvantages of using regulations to correct negative externalities ?
- 1) significant cost to government to implement legal restrictions - 2) parallel markets develop in regulated markets and can lead to crime (involvement of gangs) - 3) regulations can increase business costs (and so) prices for consumers - 4) firms can find their way around regulations - 5) firms often locate production facilities in countries with lower regulations
101
Using a diagram, explain how regulation can help to correct negative consumption externalities ?
- regulation like age restrictions cause MPB to shift inwards - ideally MPB shifts to MSB - if so, the socially efficient level of output is achieved - so welfare loss is eliminated - welfare loss is eliminated - allocative efficiency is achieved
102
How can regulation help to correct negative production externalities ?
- regulation like making steel mills have to install filters increase firms’ production costs - so MPC shifts inwards - ideally, MPC shifts to MSC - so the socially efficient level of output is achieved - so welfare loss is eliminated - and allocative efficiency is achieved
103
How can awareness creation help correct negative externalities ?
- education / negative advertising causes demand to decrease - this causes MPB to shift inwards - ideally, MPB shifts to MSB - so the socially efficient level of output is achieved - so welfare loss is eliminated - and allocative efficiency is achieved
104
How can international agreements help correct negative production externalities ?
- they help correct negative externalities by coordinating countries to reduce harmful spillover effects that cross borders
105
What is the advantage of using international agreements to correct negative production externalities ?
- big issues that countries cannot solve alone can be solved
106
What are 2 disadvantages of using international agreements to correct negative production externalities ?
- 1) some countries care more about their own economic interests rather than collective interests (eg environment) / they don’t care - 2) international agreements can be regressive to low-income countries (as HICs may exploit LICs)
107
What are tradable permits ?
- tradable permits are permits issued by the government to businesses to cap emissions at a certain level - if a business emits less than that level (they have permits left over) they can trade the permits for money
108
Explain tradable permits, using the example of carbon trading
- government sets a total limit on the CO2 emissions for an industry ( eg 100,000 tons of CO2 ) - this total limit is then divided among producers ( eg if there are 5 producers, they will be allowed to emit 20,000 tons each ) - the producers are not allowed to emit more than their CO2 allowance ( 20,000 tons each, in this example ) - the producers can sell any unused allowance - so producers are incentivised to reduce their emissions ( eg if they only use 10,000 tons out of 20,000 tons, they can sell the other 10,000 tons ) - if the government reduces the number of permits, their price and value rise, and there is a greater incentive for producers to reduce their emissions
109
What are 2 advantages of using tradable permits to correct negative production externalities ?
- 1) permits create an incentive system that is more effective at reducing CO2 than a tax - 2) using an incentive based system facilitates innovation, and firms develop technology to reduce pollution
110
What are the benefits of using an incentive based system ?
- incentive based systems facilitate innovation, and firms develop technology to reduce pollution
111
What are 3 disadvantages of using tradable permits to correct negative production externalities ?
- 1) system is complicated and expensive to set up + administer - 2) the number of permits allowed needs to be tightly controlled at an international level - 3) the permits lead to increased business costs and higher prices
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