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Micro: Chapter 16
Midterm 3
| Term | Definition |
|---|---|
| externalities | a cost/benefit that is only felt by others and doesn't affect the individual who engages in the activity; |
| positive externalities | makes someone else better off, but they don't have to compensate you for it; ex= education, flu shots/vaccinations, research & development |
| negative externalities | makes someone else worse off, but you don't have to compensate them for it |
| Why are externalities problematic? | when indiv make choices that have externalities and dont take them into account, then the end result wont maximize total benefit of socity; only take into account effect on self, not effect on others; maximize private outcomes, not overall social outcomes |
| marginal private cost (MC) | cost to the individual making the choice |
| marginal external cost (MEC) | cost to society (everyone else except the decision maker) |
| marginal social cost (MSC) | MC + MEC; the additional cost imposed on society as a whole from an additional unit of whatever good (individual plus external) |
| marginal private benefit (MB) | benefit to the individual |
| marginal external benefit (MEB) | benefit to everyone else except the decision maker |
| marginal social benefit (MSB) | MB+MSB; the additional gain to society as a whole from an additional unit of whatever good |
| 2 options for modeling externalities... | give the externality its own market; fit the externality in the market we've already seen |
| (1) give the externality its own market | modeling the MB and MC of one more unit of externality (like MB and MC of other choices) |
| marginal benefit of pollution? (or any negative externality in general..) | the benefit of not having to not make the externality; more specifically, not deviating from what you would prefer to do; ex= benefit of pollution is that companies don't have to use more expensive measures to cut down on pollution |
| (2) fit the externality in the market we've already seen | stick w/market of the good, not the market for the externality; model MSC and MSB instead of MC and MB; same models used before, addition of social costs/benefits is straightforward |
| negative externality market | MSC = MC + externality cost; bc individuals don't see the externality cost, individuals will always choose the level where MC=0; by definition of a negative externality, there is no benefit felt beyond the decision maker (MSB=MB, MEB=0) |
| marginal curves in a negative externality market | MSC=0+MEC (always increasing, MC=0); MSB=MB+0; the individual will choose to be where the MSB intercepts the x-axis. why? because that is where the firms MB=MC which means that it is the perfect amount of production FOR THE INDIVIDUAL |
| What is equilibrium? | the socially optimal level; the point where the cost of producing one more unit of ____ = benefit of producing one more unit of _____ |
| Why does MSB intersect the x-axis where it does? | firm picks some level of production it wants to do and ignores the externalities (MSC); that level of production generates some externality level; how much externality would we get if the firm did exactly what they wanted to do? |
| Why does MC = 0 on this graph? | Because we're graphing the EXTERNALITY! In a negative externality, there is no marginal cost to the individual of producing more externalities |
| Is the right level of a negative externality always not zero? | No - not if the MSC of the first unit is already greater than the MSB. Then, zero externality is socially optimal; ex = DDT, mercury in baby food, lead paint; cost is so great that there's never a point where any of it is acceptable |
| Model 2.... | graphing the good, not the externality; talking about thing that creates the externality; curves are MC (marginal cost of production ($ to make the good) and MB (marginal benefit of production ($ from selling it); cost vs benefit of producing 1 more good |
| Where does the market end up in terms of total production and price? | MC=MB; in this graph, MSC=MC+MEC and MSB=MB (no MEB bc positive externality); socially optimal point is where MSC=MB; true cost is above marginal cost, but additional expense not felt by producer; private market will overproduce |
| negative externality summary (model w/market for the externality) | market will arrive where MSB of externality = 0 and ignore the MSC; we want the market to be at the socially optimal level where MSB=MSC |
| negative externality summary (model w/market for the good) | market will arrive where MB=MC and ignore the MSC; we want the market to be at the socially optimal level where MSB = MSC of good |
| negative externality summary (end result) | any good with an externality means that the choice a private firm will make is not the socially optimal choice; private markets will overproduce - too much good and too much externality |
| positive externalities | ex= education; more productive and employable workforce, higher mobility, etc; producing goods creates an external benefit not felt by the individual |
| positive external market (model 1 when x=externalities) | MB=0 bc graphing externalities, and there's no marginal benefit to the individual for an additional unit of externality; MSB = 0+MEB; MSC=MC (MEC=0 bc positive); indiv doesn't think about MEB, so you choose to be at MSC=MC=0 |
| positive externality market (model 2 when x=good) | in this graph, you have an MB, MC, and MSB curve; socially optimal quantity is when MSB=MSC (and MSC=MC); we're going to stop too soon |
| positive externality summary (market externality) | market will arrive where MSC of externality (which is also the MC [because MEC doesn't exist])=0; MSB will be ignored; social surplus is maximized when MSB =MSC (so MC=MSB) (and MSB = MEB, because MB=0) |
| positive externality summary (market for good) | market will arrive where MB good = MC of good; socially optimal level is when MSB good = MSC good (where MSC=MC, because no MEC) |
| positive externality summary (end result) | for positive externalities, private markets will underproduce |
| externality basics: summary | externality present means the market will yield socially suboptimal result (market gets it wrong); negative= good will be over produced/consumed; positive= good will be under produced/consumed |
| dealing with externalities - how do you solve them? | direct regulation, pigouvian taxation, creation of new markets (tradable permits, property rights) |
| direct regulation | legally regulate the externality or behavior that produces it; ex EPA has regulations on lead content in gasoline, sulfur content in coal; usually act of last resort -> there are more efficient results w/lower cost to socity |
| pigouvian taxes/subsidies | negative ex= tax that makes producer feel the cost; positive ex= subsidy that makes producer feel the benefit; get individual to make same choice as society; internalizing the externality |
| adding the pigouvian tax | you can either charge the tax for every unit of the externality you produce (so MC is no longer 0, but is the cost of the PT); or you can tax the good that makes the externality, which will shift up the MC line; firm will choose socially optimal point |
| benefit of pigouvian tax | tax revenue!; we go back to being efficient, so now DWL and we get tax revenue in addition to lowering other taxes (double dividend) |
| why do economists prefer pt over regulation? | double dividend; incentives: w/regulation, less incentive to develop more efficient methods (no need for increasing production efficiency if stopped @ quota); efficiency: if there are multiple producers, taxes = less expensive burden to remove externality |
| how much should the pigouvian tax be | want the price to be as high as necessary so that the quantity is the socially optimal amount; difference between socially efficient price and MC; market will end at efficient level bc for every unit of good/externality, you now feel higher price/cost |
| efficiency and pigouvian taxes | 2 firms: we care about pollution reduction in cheapest possible manner; more efficient factories= reduce more (easier/cheaper for them to do so) and less efficient factories= reduce less (harder/more expensive for them to cut back); lower cost to society |
| permits | create a market for externalities; buying the "right" to pollute; good solution if we know level you want, but not the perfect tax (common); ex: only want 1000 tons of pollution, so let firms buy/sell permits from each other, 1 permit = 1 ton of pollution |
| Why are permits better than regulation? | invisibile hand... different costs for 2 factories? 1 will keep selling and 1 will keep buying until their costs for producing are the same; doesn't matter who starts with the permits (except for profits) |
| benefits of permits | politically friendly (between businesses not government); incentivizes technological advances and efficiency gains (each ton you don't pollute is one more you can sell) |
| property rights | assign property rights -> tell factory they have right to pollute and let fisherman pay to make them not and vice versa; end result is the same either way |
| issues with property rights | whoever starts with rights ends up being paid (is it fair?); what if there are lots of parties involved; how much you would pay to avoid something as opposed to how much you would accept to be exposed to it |
| network externalities | value of a good increases as more people use it; can mean adopting new technologies is tougher (ex: electric cars); certain products win even if inferior (VHS vs Betamax); influence firm behavior (take a profit hit for bigger market like Kindle) |
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nicook
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