What is an externality?

An uncompensated effect on a bystander from someone’s actions.

What is a negative externality?

A cost or harm to a bystander, such as pollution.

What is a positive externality?

A benefit to a bystander, such as protection from the spread of disease.

What is market failure?

When a market fails to allocate resources efficiently.

Why do externalities cause market failure?

Buyers and sellers ignore external costs or benefits.

Negative externalities cause the market to produce what quantity?

Too much compared with the social optimum.

Positive externalities cause the market to produce what quantity?

Too little compared with the social optimum.

What is the social value formula?

Private value + external benefit.

What does “internalize an externality” mean?

Change incentives so people consider effects on bystanders.

What does the demand curve represent?

Private value: buyers’ willingness to pay.

What does the supply curve represent?

Private cost: sellers’ production costs.

Where is the ordinary market equilibrium?

Where supply intersects demand.

With a negative externality, where is the social cost curve?

Above supply by the external cost per unit.

Where is the social optimum with a negative externality?

Where social cost intersects demand.

With a positive externality, where is the social value curve?

Above demand by the external benefit per unit.

Where is the social optimum with a positive externality?

Where social value intersects supply.

What should the ideal corrective tax equal?

The marginal external cost at the optimal quantity.

What should the ideal corrective subsidy equal?

The marginal external benefit at the optimal quantity.

What is a command-and-control policy?

A direct government rule, such as an emissions limit.

What are two market-based policies?

Corrective taxes/subsidies and tradable pollution permits.

What are tradable pollution permits?

Rights to emit a specified amount of pollution that firms can buy and sell.

Which firms tend to sell permits, and which buy?

Low reduction-cost firms sell; high reduction-cost firms buy.

Why can permit trading lower pollution-control costs?

Firms that can reduce pollution most cheaply do more of the reduction.

What does the Coase theorem say?

With clearly defined rights and costless bargaining, private parties can solve externalities.

What are transaction costs?

Costs of reaching and carrying out an agreement.

What can prevent private solutions?

Transaction costs, holding out for a better deal, and coordination problems.

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Econ Chapter 10

Question	Answer
What is an externality?	An uncompensated effect on a bystander from someone’s actions.
What is a negative externality?	A cost or harm to a bystander, such as pollution.
What is a positive externality?	A benefit to a bystander, such as protection from the spread of disease.
What is market failure?	When a market fails to allocate resources efficiently.
Why do externalities cause market failure?	Buyers and sellers ignore external costs or benefits.
Negative externalities cause the market to produce what quantity?	Too much compared with the social optimum.
Positive externalities cause the market to produce what quantity?	Too little compared with the social optimum.
What is the social cost formula?	Private cost + external cost.
What is the social value formula?	Private value + external benefit.
What does “internalize an externality” mean?	Change incentives so people consider effects on bystanders.
What policy corrects a negative externality?	A corrective tax.
What policy corrects a positive externality?	A corrective subsidy.
graphs and policies
What does the demand curve represent?	Private value: buyers’ willingness to pay.
What does the supply curve represent?	Private cost: sellers’ production costs.
Where is the ordinary market equilibrium?	Where supply intersects demand.
With a negative externality, where is the social cost curve?	Above supply by the external cost per unit.
Where is the social optimum with a negative externality?	Where social cost intersects demand.
With a positive externality, where is the social value curve?	Above demand by the external benefit per unit.
Where is the social optimum with a positive externality?	Where social value intersects supply.
What is another name for a corrective tax?	A Pigouvian tax.
What should the ideal corrective tax equal?	The marginal external cost at the optimal quantity.
What should the ideal corrective subsidy equal?	The marginal external benefit at the optimal quantity.
What is a command-and-control policy?	A direct government rule, such as an emissions limit.
What are two market-based policies?	Corrective taxes/subsidies and tradable pollution permits.
What are tradable pollution permits?	Rights to emit a specified amount of pollution that firms can buy and sell.
Which firms tend to sell permits, and which buy?	Low reduction-cost firms sell; high reduction-cost firms buy.
Why can permit trading lower pollution-control costs?	Firms that can reduce pollution most cheaply do more of the reduction.
private solutions
What does the Coase theorem say?	With clearly defined rights and costless bargaining, private parties can solve externalities.
What are transaction costs?	Costs of reaching and carrying out an agreement.
What can prevent private solutions?	Transaction costs, holding out for a better deal, and coordination problems.

Created by: HoteboyMikyell

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